Tax Concepts and Considerations of Municipal Bonds

 Tax Concepts and Considerations of Municipal Bonds


Bonds are available in both taxable and tax-exempt formats and there are tax concepts to consider when a person is investing in bonds. Each type of bond, whether tax GWG L bonds attorney” -exempt or not, has different tax aspects. Tax-exempt municipal bonds and taxable bonds are discussed, explaining how some of the tax rules work for these investments and their investment yields.

Acquisition of Bonds

When purchasing tax-exempt municipal bonds at face value or par, there are no instant tax consequences. When the bond is acquired between interest payment dates, the buyer pays the seller interest that has accrued since the last payment date. The interest paid in advance to the seller is treated as the cost of the investment and is treated basically as a return of some the initial investment when the interest is paid.

Bond Premium Amortization

When tax-exempt municipal bonds are purchased at a premium, the premium is amortized for the duration of the bond term. The effect of this is to decrease the cost of the investment in the bond on a pro rata basis. Thus, holding the bond to maturity means no loss recognized when the bond is paid off.

Interest Excluded From Taxable Income

Normally, tax-exempt municipal bond interest is not added to income for tax purposes (although, the interest may be taxable under alternative minimum tax rules). Also note, municipal bonds usually pay lower interest rates as compared to similar bonds that are taxable.

When comparing taxable investments to tax-free investments, the amount of interest included in income is not the most important issue. What is important is the after-tax yield. For tax-exempt municipal bonds, the after-tax yield is usually equivalent to the pre-tax yield. On the other hand, a taxable bond’s after-tax yield will be based on the amount of interest remaining after deducting the corresponding amount of income tax expense associated with the interest earned on a taxable bond.



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