Contents

Types of municipal bonds

• General Obligation Bonds are municipal bonds secured by the taxing and borrowing power of the municipality issuing it. [1]
• Revenue Bonds are municipal bonds supported by the revenue from a specific project, such as a toll bridge, highway, or local stadium. [2]
• Assessment Bonds are special types of municipal bonds used to fund a development project. Interest owed to lenders is paid by taxes levied on the community benefiting from the particular bond-funded project. [3]
• Build America Bonds are municipal bonds issued under a program begun in 2008. Through the BAB program, the Federal government directly subsidizes taxable municipal bonds instead of subsidizing municipal bonds via a tax break for their purchasers. This opens the market up to a wider range of participants, including tax-exempt institutions and individuals with sufficient tax-exempt space.

Taxation

Interest

Interest from municipal bonds is generally exempt from federal income tax and the issuing state’s income tax. [note 1] However, there are a few exceptions.

• Interest from some municipal bonds is subject to Alternative Minimum Tax (AMT) although whether you actually have to pay AMT depends on your individual circumstances. Such bonds are commonly referred to as AMT bonds.
• Some states charge income tax on interest from their own municipal bonds.

Areas of note:

• Puerto Rico, Guam, and US Virgin Islands: No state can tax bond interest issued by US territories. [4]
• New York City: Bonds issued in NY may be triple tax-exempt from city, state, and federal income taxes. [4]
• Utah: Utah reciprocates taxation. Utah does not tax its own bonds, but also does not tax bonds issued in states that do not tax Utah bonds. [4]
• Washington D.C.: Does not tax in-state or out-of-state municipal bonds. [4]

Capital gains/losses

Capital gains and losses are subject to taxation. One notable point is the treatment of short-term capital losses. If you received exempt-interest dividends at least part of your loss is disallowed. You can deduct only the amount of loss that is more than the exempt-interest dividends. Report the loss as a short-term capital loss. See Publication 550 (2012), Investment Income and Expenses and Short-Term Capital Losses for more details.