Bgd Bridge

Four tax incentives of municipal bonds

In today's tax environment, nothing is certain. However, as things stand now, high-income taxpayers may continue to value municipal bonds ("munis") and muni bond funds. Just consider these four tax incentives.

  1. Interest income from munis is exempt from federal income tax. This is a major benefit to taxpayers in the top tax brackets, especially when compared to taxable investments. For example, to someone in the top 39.6 percent tax bracket, a AAA-rated muni earning 4 percent is preferable to a taxable corporate bond earning 5 percent.
  2. Interest income from munis is exempt from state income tax if issued by a municipality or other authority within your state. This is a significant "double tax break" for residents of high-tax states.
  3. Interest income from munis doesn't count toward your adjusted gross income (AGI) for tax return purposes. This could increase certain tax benefits, such as deductions for medical expenses or charitable gifts, or avoid cutbacks.
  4. Interest income from munis doesn't count in the tax calculation of the net investment income tax (NII). Currently, a 3.8 percent surcharge applies to the lower amount of your NII (which includes most investment income items) or modified adjusted gross income (MAGI) above $200,000 for single filers and $250,000 for joint filers.

While these tax incentives exist, this should not lead you to believe munis are completely tax-free. For example, if you buy certain munis, called "private activity bonds," it may create alternative minimum tax (AMT) complications. You will owe capital gains tax when you sell munis at a profit.

Also, remember that there's more to investing than just taxes. Take all the relevant financial factors into account, including the suitability of munis in your portfolio. The rules related to munis are complex and can change. Call if you need help.

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