How to Buy Municipal Bonds in Pennsylvania
Pennsylvania law allows the purchase of municipal bonds issued within the state to be exempt from state income tax in addition to the federal income tax exemption. Consequently, there is high demand for these bonds among Pennsylvania residents. Investors need to be versed in exactly what securities to consider and how to avoid alternative minimum tax when buying Pennsylvania municipal bonds.
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General Information
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Pennsylvania is among a handful of states that allows its residents to pass income derived from the coupon stream of Pennsylvania issued bonds free of federal and state taxes. This represents a 3 percent advantage over buying municipal bonds from other states. For residents taxed in the top federal tax bracket, the total return from a Pennsylvania state bond is comparable to nearly a 40 percent tax advantage over similarly yielding taxable debt.
Investment in Individual Municipal Bonds
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Investors using investment advisers, fee-based advisers or certified investment program managers may chose to buy their Pennsylvania bonds individually. Municipal bonds come in $5,000 minimum denominations. Investors should own at least 10 different issues in order to diversify their holdings. Bond buyers should limit the maturity of their purchases to not exceed 10 years in order to avoid capital loss from market volatility.
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Pennsylvania Bond Funds
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Their are a variety of Pennsylvania bond funds that buy only state and local debt eligible for Pennsylvania tax exemption. Some bonds in the fund will be from United States commonwealths and territories such as Puerto Rico, which also enjoy tax exemption from all state taxes. These professionally managed funds allow investors to simply receive regular dividend checks which accumulate as interest payments. Investors receive and annual accounting statements for tax purposes.
Tax Concerns
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Pennsylvania tax exemption is for the income stream each bond provides. If profits are made from the purchase and sale of a Pennsylvania bond or mutual fund these profits are taxable. They are taxable as either long or short term capital gains depending on the length of investment. In addition, certain types of municipal bonds may trigger alternative minimum tax, an unwanted tax consequence depending on the nature and source of your personal income. Consult a tax professional about your own circumstances.
Callable Bonds
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Pennsylvania bonds, with rare exceptions, will have extraordinary call features. This means that at the decision of the issuer they may redeem bonds of any maturity on short notice. Bond holders will receive cash plus accrued interest for their bonds. Investors will have to accept the current, and probably lower, interest rates available for reinvestment.
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