Unfortunately, most people have limited options for significantly reducing their tax burdens. And that may be why municipal bonds are so popular. It has been estimated that municipal bonds save high-income American bond investors around $20 billion a year in federal income taxes.2
When Governments Owe You
Municipal bonds are debt obligations issued by state and local government entities. With a few exceptions, they pay interest that is not subject to federal income tax. Municipal bonds typically fall into one of two categories.
General obligation bonds are issued to raise capital immediately, usually to cover expenses or refinance public debt. They are commonly repaid through taxes levied by the issuing agency.
Revenue bonds are issued to fund specific revenue-generating projects, such as sports stadiums, redevelopment projects, and toll roads. Revenue bonds are typically repaid from the revenues generated by the finished projects.
Because municipal bonds offer interest payments that are typically free of federal income tax, they tend to pay lower interest rates than those offered by taxable bonds. As a result, the tax benefits offered by municipal bonds tend to be more valuable to people in higher income tax brackets.
If a bond was issued by a municipality outside the state in which you reside, the interest could be subject to state and local income taxes. If you sell a municipal bond at a profit, you could incur capital gains taxes. Some municipal bond interest could be subject to the federal alternative minimum tax. The principal value of bonds may fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk.
Municipal bonds offer an appealing opportunity to generate income that is free of federal income taxes, but they are not for everyone. Call to discuss the tax implications of your current investing strategy.
1) Gallup, 2010
2) TheBigMoney.com, April 12, 2010
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.
For more information call your Naperville CPA and Naperville Financial Services professionals at LewisCPA.us
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