Whether they're issued at the federal, state, or local level, all government bonds have some sort of tax exemption.
4 minute read Taxes on investments Taxes on investments Taxes on investmentsIncome from bonds issued by the federal government and its agencies, including Treasury securities, is generally exempt from state and local taxes.
If you own a bond, mutual fund or ETF (exchange-traded fund), you'll need to calculate the amount of income you earned from the fund's government bond holdings (if any) in order to take advantage of this exemption when you file your taxes—it won't be reflected on the tax forms issued by your investment company.
A debt security (IOU) issued by a corporation, government, or government agency in exchange for the money the bondholder lends it. In most instances, the issuer agrees to pay back the loan by a specific date and make regular interest payments until that date.
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
An investment with characteristics of both mutual funds and individual stocks. Many ETFs track an index, a commodity, or a basket of assets. Unlike mutual funds, ETFs can be traded throughout the day. ETFs often have lower expense ratios but must be purchased and sold through a broker, which means you may incur commissions.
Income from bonds issued by state, city, and local governments (municipal bonds, or munis) is generally free from federal taxes.* You will, however, have to report this income when filing your taxes.
Municipal bond income is also usually free from state tax in the state where the bond was issued. However, keep in mind that:
Depending on the laws where you live, income from municipal bonds also may be exempt from local taxes. Talk to a tax advisor for more information about the rules in your state.
Private activity bonds are municipal bonds that are issued to raise money for a private project (as opposed to a project for the good of the public). These bonds are exempt from federal taxes under the regular income tax system, but subject to tax under the alternative minimum tax system.
If you invest in municipal bonds through a bond fund, income from private activity bonds, if any, will be reported to you in Box 11 of your 1099-DIV.
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*Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.
Investments in bonds are subject to interest rate, credit, and inflation risk.
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Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice. We recommend you consult a tax and/or legal adviser about your individual situation.
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