Municipal Bonds and Their Tax Advantages

State and local governments often borrow money to supplement tax revenues and to finance projects such as new highways, buildings, or public works improvements. Such bonds are known as municipal bonds (munis) or tax-exempt bonds.

There are many different types of municipal bonds. Some of the most common types include general obligation, revenue, private-activity, zero-coupon, floating-rate, refunded/pre-refunded, and Build America Bonds. A single bond may fall into more than one of those categories.

Bonds are rated for their creditworthiness by an independent rating agency, which issues a letter grade that indicates its opinion of the bonds quality. (Some bonds are ungraded, not necessarily because they are unsound investments but because the bond issuer feels the offering is too small to justify the cost of having it rated.)

When choosing investments, many bond investors focus only on yield and the creditworthiness of the borrower. However, there are many other factors to consider when deciding whether and how to invest in municipal bonds.

Municipal Bonds and Tax Planning

Even though the interest from municipal bonds is generally exempt from federal income tax, there are other tax issues you need to keep in mind when considering whether to purchase a muni.

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