Tax exemption is one thing that most of us want to have on our hard earned money; luckily there are a few conditions that can lead to tax exemptions as given below.

  • As per the federal law, the income that you receive as a result of investing in municipal bonds is exempted from any federal income taxes.
  • Majority of the states offer tax exemptions on state and local taxes on the income earned from securities issues by the governmental units.
  • Income from bonds issued by U.S territories and possessions is also exempted from any state or local taxes in all 50 states.

The advantages of tax exemption can be evaluated by comparing the tax exempted income with normal income. Take municipal security as an example: assume you are in the 33% federal tax bracket, file a joint return and with your spouse, claim $210,000 in taxable income.

Now assume you have $30,000 to invest and you are considering two investment alternatives: a tax-exempt municipal bond yielding 5.0%, and a taxable corporate bond yielding 7.0%.

Which investment will draw more juice for you?

If you put your money in the municipal bond, you’d earn $1,500 in interest (at 5.0% yield) and not pay any federal income taxes. The taxable bond investment, however, would provide you only $1,407 in income after federal income taxes had been deducted (a 4.7% yield).

It can be concluded that municipal bonds will definitely provide better yield after taxes. These advantages of tax exemption can further be maximized if compared with state and local income taxes, at the end of the day numbers will speak in favor of such tax exemption schemes.

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