![]() The municipal bond in this case offers a better taxable-equivalent yield earning $400 tax-free annually. However, a person in the 35% tax bracket must pay 35% of the $600 in federal income taxes, which is $210 in taxes resulting in $390 after taxes. On an investment of $10,000, the bank CD earns $600 in annual interest while the municipal bond earns $400. ![]() Let’s say that a bank CD is paying 6% and a municipal bond issued in your state yields 4%. ![]() Taxable-equivalent yield is simple to understand as a concept. To compare the tax-free interest from municipal bonds to other taxable interest-bearing investments, people often compare the “taxable-equivalent yield” of a tax-exempt investment to a taxable investment. A person in the 35% tax bracket receives more benefit from the tax savings than does a person in the 25% tax bracket. Most municipal bond interest is also free of AMT or the alternative minimum tax.Īs a result, the higher the investor’s tax bracket, the benefit of the tax-free income becomes greater. Other tax exemptions can include being free of city income taxes as well in cities like New York City when qualifying municipal bonds are purchased. (We will cover state taxation rules in a later chapter.) However, if the same LA resident purchased a Texas municipal bond, the income would still be tax-free on a federal level, but the California resident would owe California state income taxes since it is a bond issued out-of-state. For instance, a resident of Los Angeles can buy any municipal bond issued by a municipality in California and will not have to pay California state income taxes on the interest income. In most states, the interest income from municipal bonds issued by an issuer in the state is free from state income taxes in that state. ![]()
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