Municipal bonds, also known as munis, are the main type of tax-exempt bonds. Munis are issued by states, counties, cities, and other government agencies to fund major capital projects, such as building schools, hospitals, highways, and other public buildings. Any interest income from muni bonds is generally not subject to federal income tax.
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Bonds are divided into two classes: taxable and tax-exempt. A bond's tax-exempt status applies only to the bond's interest income. Any capital gain...
Municipal bonds, also known as munis, are the main type of tax-exempt bonds. Munis are issued by states, counties, cities, and other government age...
Here are a few strategies for avoiding – or at least reducing – the taxes you pay on bonds.Hold the bond in a tax-advantaged account. When you inve...
Here are a few strategies for avoiding – or at least reducing – the taxes you pay on bonds.
Bonds and bond funds generate two types of income: interest and capital gains.
Then the gain is taxed at your ordinary income tax rates. Long-term capital gains apply if you hold the bond for more than one year.
With a zero-coupon bond , you buy the bond at a discount from its face value, don't receive interest payments during the bond's term, and are paid the bond's face amount when it matures.
There are seven tax brackets, ranging from 10% to 37%. So if you're in the 37% tax bracket, you'll pay a 37% federal income tax rate on your bond interest. 2020 Tax Brackets.
Municipal bonds, aka munis, are the main type of tax-exempt bonds. Munis are issued by states, counties, cities, and other government agencies to fund major capital projects, such as building schools, hospitals, highways, and other public buildings.
Bonds are a type of debt instrument. When you buy a bond, you're loaning money to the government or company that issued it; in return, that entity pays you interest. Most bonds pay a fixed, predetermined rate of interest over their lifespan.
Every year, bondholders ritually fill out IRS tax form 1099-INT, to report their annual taxable interest income. 1 While at first glance, this document offers straightforward guidelines for declaring tax on income generated from the stated rates of interest, there are often complex factors fixed income investors must heed. This article explores the finer points of bond taxation rules for government, corporate and municipal bonds.
As discussed, when a bond is issued at a discount, a pro-rated portion of the discount is reported as income by the taxpayer, every year until maturity. 1 When bonds are purchased at a premium (greater than $1,000 per bond), a pro-rated portion of the amount over par can be deducted annually, on the purchaser's tax return.
Municipal Bonds. Municipal bonds are often favored by high-income investors looking to reduce their taxable investment income. The interest from these bonds is tax free at the federal, state and local levels, as long as investors reside in the same state or municipality as the issuers.
Savings bonds are issued by governments to the public and are deemed safe investment vehicles, with many benefits. Series E and EE savings bonds are also state and local tax free, however their interest income may be deferred until maturity. 4 Series H and HH bonds pay taxable interest semi-annually until maturity, while Series I bonds also pay taxable interest, which may likewise be deferred. 5 6 The interest from Series E and I bonds may also be excluded from income, if the proceeds are used to pay higher education expenses. 7
Zero-coupon bonds are issued by governments at discounts and they mature at par values, where the amount of the spread is divided equally among the number of years to maturity. They are consequently taxed as interest, just like any other original issue discount bond. 3 .
For example, if an investor buys 100 bonds for $118,000 and holds them for 18 years until they mature, they may deduct $1,000 each year until maturity. That investor would also enjoy the option of deducting nothing each year and simply declaring a capital loss when either redeeming the bonds at maturity or selling them for a loss. 11
While IRS tax form 1099-INT offers bondholders straightforward guidelines for declaring tax on income generated from the stated rate of interest , there are often complex factors that fixed income investors must heed.
When electronic EE Bonds in a TreasuryDirect account stop earning interest, they are automatically cashed and the interest earned is reported to the IRS.
put off ( defer) reporting the interest until you file a federal income tax return for the year in which the first of these events occurs: you cash the bond and receive what the bond is worth, including the interest, or. you give up ownership of the bond and the bond is reissued, or.
Once you start to report the interest every year (for example, for a child in the child's Social Security Number), you must continue to do so every year after that. for all your savings bonds (or, for example, all the child's bonds) and any you acquire (or, the child acquires) in the future.
Whether you are reporting interest at the end of the bond's life or every year, you report the interest from your bonds on your federal income tax return on the same line with other interest income.
If a financial institution pays the bond, you will receive a paper 1099-INT from that financial institution either soon after you cash your bonds or within the first two months after the end of the year in which you cash your bonds.
Note: You (or the child if a bond is in the child's name) do not actually receive the interest every year even if you report it that way. The interest that the bond earns is reported on a 1099-INT after the bond is cashed or is reissued to reflect a taxable change in ownership. The 1099-INT will show all the interest the bond has earned over the years. Go to IRS Publication 550, Investment Income and Expenses, for instructions on how to tell the IRS that you already reported some or all of that interest in earlier years.
Bonds and bond funds are taxed in 2 ways—based on the income that's distributed and on any gains if the investment is sold at a profit.
The income from taxable bond funds is generally taxed at the federal and state level at ordinary income tax rates in the year it was earned . Funds that exclusively hold U.S. Treasury bonds may be exempt from state taxes.
Because individual bonds and bond funds distribute income differently and treat your principal differently, there are also some differences in how that income and any capital gains are taxed.
Taxes on bond funds. Mutual funds that invest in bonds typically provide regular income from a portfolio of many securities. As a result, the tax on the income is dependent on the types of securities held by the fund. What’s more, since fund managers regularly buy and sell bonds, there may also be capital gains and losses incurred.
As a result, you likely won't incur any capital gains tax. If, however, you purchase a municipal bond in the secondary market at a discount to the revised issue price, you can be taxed as either a capital gain or ordinary income, depending on the size of the discount and the years to maturity of the bond.
As a result, you likely won't incur any capital gains tax.
Interest income generated by municipal bonds is generally not subject to federal taxes, and may be tax-exempt at the state and local level as well, if the bonds were issued by the state in which you live. To learn more about municipal bond and tax-free investing, please visit our Fixed Income Research Center.
What you can do: For bonds held at Schwab, you can find out if a municipal bond is subject to AMT by accessing the “Research” page after logging into schwab.com, searching for a municipal bond and viewing its “Security Description” page. You can also contact a Schwab Fixed Income Specialist at 877-566-7982. 3.
For bonds held at Schwab, you can find your adjusted cost basis on the “Positions” page after you log into schwab.com.
1. De minimis tax. The de minimis tax applies to munis that you acquired at a market discount. The de minimis rule says that for bonds purchased at a discount of more than 0.25% for each full year from the time of purchase to maturity, gains resulting from the discount are taxed as ordinary income rather than capital gains. The ordinary income tax rate is generally greater than the capital gains rate, which could result in a greater bite out of your yield.
What you can do: To avoid the de minimis tax rule, consider purchasing bonds priced at par or at a premium to their face value. Paying a premium may mean having to make adjustments to your tax filing, but the associated tax benefits more than offset the added complication, in our view. In addition, if a bond is selling at a premium, it’s likely because it is offering a high coupon rate.
For example, take a bond that matures in 10 years with a face value of 100. The de minimis “breakpoint” on this bond is 97.5 (100 – [0.25 × 10 years]). If you bought this bond for less than 97.5, you would be required to pay ordinary income tax on the discount.
There are two parallel income tax systems in the United States: ordinary income tax and alternative minimum tax (AMT), which disallows a number of deductions that are allowed in the ordinary income tax code. Taxpayers must calculate their tax under each system, then pay whichever is higher—ordinary or AMT.
Although municipal bonds generally aren’t subject to federal taxes, the IRS does include income from such bonds in your modified adjusted gross income (MAGI) when determining how much of your Social Security benefit is taxable. If half of your Social Security benefit plus other income, including tax-exempt municipal bond interest, amounts to more than $44,000 for a joint return ($34,000 for individual), up to 85% of your Social Security benefits may be taxable.