How to Tell if Municipal Bonds Have Tax Consequences
All municipal bonds are exempt from federal income tax. However, many bond issues are subject to various state, local, capital gains, ordinary income and alternative minimum taxes.
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Instructions
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Municipal bonds are generally exempt from state tax in your state of residence. Municipal bonds from other states are never exempt from state income tax in your resident state. Know the purpose of the bonds you own. Each state posts a list of state issues by purpose that qualify for full state tax exemption.
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Puerto Rico, Guam, and Virgin Islands general obligation bonds are the only municipals that are tax exempt in every state and locality. This includes federal, state tax and city income taxes.
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Use your brokerage confirmation of purchase and ascertain when the bonds were bought. Municipal bonds purchased at a discount at the time of issuance accrue tax free until maturity. Bonds purchased in the secondary market at a discount accrue ordinary income each year net of the effect of any accrued original issue discount.
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Bonds purchased at a premium do not entitle the holder to any tax deduction of the premium price above par.
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When tax planning be aware of your amortized or accreted cost. Bonds sold at a loss are eligible for capital loss treatments. Bonds sold at a profit are subject to capital gains tax. Both sale and purchase are also subject to short term or long term capital gains treatment as appropriate.
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Your bond confirmation must show whether your purchase is subject to tax preference items. Municipal bonds issued under legal "private activity" restrictions may subject the bondholder to alternative minimum tax (AMT). "Private Activity" covers a broad array of bonds including certain non-profit hospital bonds, airport bonds, and certain housing bonds. Income from these bonds is a tax preference item. If your income exceeds certain levels and you own "Private Activity" bonds you are subject to AMT tax. Consult your accountant for further information.
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Tips & Warnings
Keep careful records for tax purposes and in order to understand the subtle aspects of your municipal purchase.
Try and understand these important tax items before you enter into any bond transaction. Avoid rather than undo municipal bond tax problems.
