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Tax-Exempt Interest Income: Your Path to Tax-Free Earnings
- Many investors are attracted to municipal bonds and U.S. Treasury bonds, in particular, for their tax-exempt status.
- Tax-exempt interest refers to interest that's excluded from your gross income calculation at the federal level, the state/local level, or both.
- Tax-exempt interest comes mainly from municipal bonds and U.S. Treasury bonds.
- Interest from Treasury bonds, bills, and notes is federally taxed.
- Muni bond interest is not federally taxed and may be exempt from state and local taxes.
- Municipal bonds, or muni bonds, are typically issued by state and local governments and U.S. territories. They finance government operations and projects, such as building schools or restoring roads.
- Bondholders receive two interest, or coupon, payments a year, which are not subject to federal income tax. After a set period of time, bondholders receive their original investment back.
- Interest earned from Series EE and Series I Savings Bonds are also exempt from state and local taxes.
- While Treasurys are backed by the federal government and are considered the closest thing to a risk-free investment, investors still owe federal taxes on the interest income.
- Investment gains in a 529 college savings plan are not taxable at the federal or state levels if the funds are used for education.
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