Content
- What Are Municipal Bonds?
- An Investment For Today's Tax-conscious Investor
- How Safe Are Municipal Bonds?
- The Advantages of Tax Exemption
- Understanding Yields
- Understanding Market Risk
- Understanding Calls
- Gains and Losses
- Types of Tax-exempt Municipal Bonds
- Bonds With Special Investment Features
- Taxable Municipal Bonds
- Other Basic Facts
- The Tax-exempt Municipal Bond Market-How Big and Who Buys?
- Tax-exempt/Taxable Yield Equivalents
- State Taxation of Municipal Bonds for Individuals
- State Taxation of Municipal Bonds for Corporations
- Glossary
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association (SIFMA) from our membership and other sources believed by SIFMA to be accurate and reliable. By providing this general information, SIFMA is neither recommending investing in securities, nor providing investment advice for any investor. Due to rapidly changing market conditions and the complexity of investment decisions, please consult your investment advisor regarding investment decisions.
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- Bond Basics
- The Advantages of Tax Exemption
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The Advantages of Tax Exemption
Under present federal income tax law, the interest income you receive from investing in municipal bonds is not subject to federal income taxes.* In most states, interest income received from securities issued by governmental units within that state is also exempt from state and local taxes. In addition, interest income from bonds issued by U.S. territories and possessions is exempt from federal, state and local income taxes in all 50 states.
One of the best ways to appreciate the tax-exempt advantage of a municipal bond is to compare it to a taxable investment. For example, assume you are in the 33% federal tax bracket, file a joint return and with your spouse, claim $210,000 in taxable income.
Now assume you have $30,000 to invest and you are considering two alternative investments: a tax-exempt municipal bond yielding 5.0%, and a taxable corporate bond yielding 7.0%. Which investment will prove most advantageous in terms of after-tax income?
If you invest your money in the municipal bond, you would earn $1,500 in interest (a 5.0% yield) and not pay any federal income taxes. As noted in the table below, the taxable bond investment, however, would provide you only $1,407 in income after federal income taxes had been deducted (a 4.7% yield).
| EFFECT OF FEDERAL INCOME TAXES ON YIELDS OF TAX-EXEMPT AND TAXABLE INSTRUMENTS: | ||
|---|---|---|
| 5.0% TAX-EXEMPT BOND | 7.0% TAXABLE BOND | |
| CASH INVESTMENT | $ 30,000 |
$ 30,000 |
| INTEREST | $ 1,500 |
$ 2,100 |
| FEDERAL INCOME TAX IN THE 33% MARGINAL TAX BRACKET | 0 |
$ 693 |
| NET RETURN | $ 1,500 |
$ 1,407 |
| YIELD ON INVESTMENT AFTER TAXES | 5.0% |
4.7% |
As you can see, the municipal bond would provide the better yield after taxes are taken into account. The tax-exempt bond yield advantage would be an even better investment if you accounted for state and local income taxes when calculating returns on the taxable bond investment.
To determine the yield you would need to earn from a taxable investment to equal the yield on a tax-exempt security, click here, or visit investinginbonds.com to use our Tax-Free vs. Taxable Yield Comparison Calculator online.
* If you are subject to the Alternative Minimum Tax (AMT), you may have to include interest income from certain municipal securities in calculating your income tax.
