Contact Us
Firm Overview
Why Legend Is Different
Client Types
Professional Biographies
Frequently & Rarely Asked Questions
Risk Spectrum
Investment Strategies
Second Opinion
Global Investment Pulse
Event Calendar
Press Center
Legend News
Clients Only
Career Opportunities
Directions
Newsletter Sign-up
Site Search
Site Map
Home
Tell A Friend About This Website
 
 
 
Informational Booklets   
Phone: (412) 635-9210
  (888) 236-5960
Connect With Legend:
Subscribe to me on YouTube

Tax Pros And Cons Of Municipal Bonds

For many investors, an investment in municipal bonds can be a sweet deal. Like other bonds, munis provide regular interest payments. But whereas interest on Treasury and corporate bonds is taxed as regular income, at a rate as high as 35% plus the applicable state income tax rate, the income from munis is exempt from federal tax and may also avoid state taxes. The same is true of distributions from a qualified municipal bond fund. And while munis typically offer lower yields than taxable bonds, municipal bonds and bond funds may provide higher after-tax returns to investors in high tax brackets. But munis also come with several drawbacks, and if you’re not careful, your investment in municipal bonds or bond funds could trigger unexpected tax liability.

On the plus side, there are at least four significant tax advantages to investing in munis.

1. First, of course, is that exemption from federal income tax. Suppose you own a $10,000 corporate bond that pays 6% interest, and you’re in the 25% federal income tax bracket. Though you’ll receive $600 in annual income, you’ll lose $150 to the IRS, leaving you with only a 4.5% after-tax return. But with a muni, federal tax isn’t an issue.

2. The interest income from munis is also exempt from state tax as long as the bonds are issued within your state. That state tax break effectively increases the after-tax return on your investment.

3. Interest payments from munis don’t increase your adjusted gross income (AGI). That’s beneficial because many tax breaks are phased out when AGI exceeds specified levels.

4. The higher your income, the more likely you are to gain from an investment in munis. That’s because the value of tax-exempt income rises as you move into higher tax brackets. For example, if you’re in the 25% bracket, a municipal bond paying 4% will give you as much after-tax income as a taxable bond with a 5.33% yield. But if you’re in the 35% bracket, it will take a yield of 6.15% to match the muni’s 4%. The accompanying chart—“What’s A Muni Worth To You?”—illustrates this notion of “taxable-equivalent yield.”

Yet as helpful as muni investments may be to many investors, they also bring potential tax traps. Consider these six:

1. If your municipal bonds are issued by an entity in another state, you’ll owe state income tax on the interest you receive.

2. If you sell a municipal bond for more than its face value, you may owe federal capital gains tax. The prices of munis, like those of other bonds, fluctuate with changes in interest rates, and if rates dip below the coupon rate on a bond you own, another investor may be willing to pay a higher price for it. But if you bought a $10,000 bond at its face value and sell it for $10,500, you’ll pay capital gains tax on your $500 profit. (The capital gains rate for most taxpayers is 15% on investments held for more than a year; short-term gains are taxed as ordinary income.)

3. The sale of a municipal bond can also result in ordinary income tax. Suppose you acquire a discounted muni in the secondary market and then sell it. Your profit will be taxed as ordinary income to the extent of the accrued discount. For example, if you pay $9,500 for a muni with a face value of $10,000 and a maturity of 10 years and then sell it for $9,800 after five years—at a $300 gain—$250 of your profit will be taxed as ordinary income and $50 taxed as a capital gain.

4. Selling a muni bought at a premium, however, won’t produce any tax benefit. For example, if you buy a bond for $10,500 that will mature at $10,000 and you hold it until maturity, you can’t claim a capital loss or any other deduction on your tax return. Tax rules require you to amortize the premium over the life of the bond.

5. Interest payments from “private activity” municipal bonds, used to finance airport construction or other nongovernmental projects, aren’t exempt from federal tax for taxpayers who owe the alternative minimum tax (AMT).

6. Owning munis could result in tax on Social Security retirement benefits. Normally, Social Security benefits are exempt from increased tax. However, if your “provisional income” exceeds specified levels, you’ll be taxed on up to 85% of your benefits. Provisional income is equal to the sum of your AGI plus any tax-exempt interest—such as income from munis and municipal bond funds—and 50% of your Social Security benefits.

Weighing munis’ potential benefits and drawbacks involves complex calculations and depends on each investor’s needs and circumstances. If you’d like to discuss the possible role of municipal bonds or bond funds in your portfolio, please give us a call.


This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.


INDEX
  • How To Spell Estate Tax Relief
  • One Last Shot At A Tax Exemption
  • 5 Ways That Can Help You Pay For Higher Education
  • Seven Smart Money Moves You Should Make In 2017
  • Sticking With The Fundamentals
  • 17 Midyear Tax Moves You Still Can Make In '17
  • A Quick Overview Of Preferred Securities
  • Weigh Five 401(k) Options When Leaving A Job
  • Locate A Tax Shelter Near A School
  • How To Improve Chances For College Financial Aid
  • What Would You Do For A Bigger Salary Or More Benefits?
  • 7 Late Moves To Cut Taxes This Year
  • Seven Good Reasons To Create And Fund A Trust
  • A Good Time To Remember How Long-Term Investors Must Think
  • Remember The Lesson Of Rebalancing
  • Section 529 Plans Keep Getting Better And Better
  • Three Ways You Can Play Good Stock Market Defense
  • When Can You Reconvert To A Roth?
  • 8 Compelling Tax Reasons For Roth IRA Conversion
  • Steer Clear Of These 7 Traps For IRA Owners
  • Make Sure That You Comply With All The RMD Rules
  • How A Financial Advisor Can Help
  • Rising Housing Prices May Be Sign That New Bubble Is Forming
  • After Five Great Years For Stocks, What's Next?
  • What Are Latest Trends In Prenups?
  • The Three Biggest Financial Mistakes That You Can Make
  • 4 Of The Main Reasons To Keep Your Bypass Trust
  • Seven Steps After A Spouse's Sudden Death
  • 7 Expired Tax Breaks That Were Given A Longer Life
  • Will Record Profit Margins Upend The Bull Market?
  • 14 Top Year-End Tax Moves For Individuals In 2014
  • Be An Elephant And Downplay Talk Of Bulls And Bears
  • Five Financial Vows For Newlyweds
  • Will Record Profit Margins Cause Stock Prices To Plunge?
  • Ins And Outs Of Nondeductible IRAs
  • Identifying Investment Risk And Coping With It
  • How Best To Leave IRAs To Your Grandchildren
  • 4 Tips For Assembling A College Savings Plan
  • Don't Be Shocked If Your Tax Deductions Are Slashed
  • 2013 Was A Poor Year For Diversification
  • Risk Rose Slightly In January, But Has Decreased In February
  • Expenses And Behavior Are Key To Investment Success
  • Five-Year Returns Show Why Diversification Is Key
  • Where Can You Invest For Safety?
  • Perspective On Stock Market Trends
  • Find Extra Benefits In DI Insurance
  • Crash Course On Paying For College
  • A Realistic Look At A Hot Topic: Dividend Stocks
  • Don't Ignore These Tips About TIPS
  • Investors Flee Stocks At Precisely The Wrong Time
  • Take A Closer Look At Your RMDs
  • 10 Reasons For The IRS To Flag Your Return
  • Economic Growth Set To Slow Down Around The Globe
  • Where Will You Live After You Retire?
  • Muni Bonds May Show Gains As Tax Increases Approach
  • Two Investment Principles In Tandem
  • Is It Finally Time To Refinance?
  • Do You Understand Investments?
  • The Best Way To Gauge If The Market Is Overvalued
  • Should You Take Social Security Early Or Late?
  • Identity Theft In The New Year
  • Preserving Assets For Generations To Come
  • Managed Futures Mutual Fund Update
  • Give Away Gifts With No Gift Tax
  • Saving For Retirement
  • 21 Shocking But True Statistics About Retirement
  • Why You Shouldn't Do Your Own Estate Planning
  • Take The Time To Give Lifetime Gifts
  • What Does The Downgrade Of U.S. Debt Really Mean?
  • Should You Give Gift Cards? They May Not Be Used
  • What Do You Want Your Legacy To Be?
  • Breaking Up Doesn't Have To Be Hard
  • Do You Have An Administrative Trustee?
  • Will The New Financial Reform Law Benefit You?
  • Roth Conversion Can Hurt College Aid
  • Do Second-To-Die Policies Merit A Second Chance?
  • It's NOT The Economy, Stupid!
  • Biggest Estate Tax Problem? Income Tax
  • The Ins And Outs Of Lifetime Gifting
  • What To Do If Your College Savings Plan Is Battered
  • Identifying And Fixing The Global Economy's Woes
  • Uncle Sam Changes Financial Aid Rules
  • Retirees Eligible For Many Tax Cuts In Recovery Act
  • Funding College Savings Plans For A Grandchild
  • An Update On College Savings Plans
  • Five Smart IRA Ideas For Pre-Retirees
  • Does Your 529 College Savings Plan Match Up?
  • A Reverse Mortgage For Mom And Dad
  • Tax Pros And Cons Of Municipal Bonds
  • How The Bankruptcy Law Affects Wealthy Individuals
  • Limits of Family Limited Partnerships
  • They Don't Call 'Em Trusts For Nothing
  • The Roth 401(k) - Is It Right For You?
  • Planning Ahead A Couple Of Generations
  • Use FLPs To Transfer Assets And Cut Estate Taxes
  • What You Need To Know About The AMT In 2008
  • Coping With Estate Tax Uncertainties
  • Thinking of Remarrying? Think Prenup
  • Many Americans Fail To Take Care Of Financial Basics
  • Beware Of Social Security Identity Theft
  • Regulatory Guidelines Update
  • Energy Systems Scale and Timeline
  • Free Credit Reports Available Online
  • Don't Forget About Roth 401(k)
  • The Oil Patch Profit Squeeze
  • Understanding the Importance of a Fiduciary Standard
  • Timber As A Liquid Investment
  • Emerging Market Food Consumption Growth Equals Rising Prices
  • Ethanol: Salvation or Panacea?
  • Timber Facts
  • Bank Loan Funds - A Primer
  • The Dangers of Medical Identity Fraud
  • A Primer On Managed Futures
  • REITS: A Very Good Portfolio Diversifier, But Should You Invest In Them?
  • Does Investing Internationally Still Diversify Your Portfolio?
  • Another Way To View The Current Valuation Of REIT Sector
  • Understanding Risk-Preparing For The Unseen
  • Why Not Alternative Fixed Income Investments?
  • How Dangerous Is A Dollar Crash?
  • What Is Shorting Expense?
  • How Volatile Can The Stock Market Be?
  • GMO 7-Year Asset Class Return Forecast Is Bleak
  • Too Many ''Phish'' In The Sea
  • The Case For Industrial Metals
  • Ways To Improve The Score
  • Know The Score
  • Total Credit Market Debt (All Sectors) As % Of U.S. GDP
  • To Reinvest Or Not To Reinvest
  • Just How Expensive Is The Market?
  • Beware of Brokerage Firms' Misconduct
  • Identity Theft : Correct Those Credit Reporting Errors
  • Risk-Controlled Investing
  • What Do Rising Interest Rates Mean For Money Market Yields?
  • Q & A With Robert Arnott
  • Identity Theft : Applying For Credit? Better Check Your Credit Report First
  • Identity Theft: Everyday Prevention
  • Identity Theft: Help Is On Its Way
  • Identity Theft: Tips to Protect Yourself
  • Identity Theft: A Note About Social Security Numbers
  • Identity Theft: What Documents Should You Shred Or Store?
  • Identity Theft : Don't Fall For That E-Mail!
  • Identity Theft : One More Reason To Protect Your Credit
  • Section 529 Plans Are Popular But Not The Only Way To Go
  • Exit Gracefully: How Business Owners Should Plan For A Comfortable Retirement
  • The Importance Of Commodities In A Portfolio
  • A Tale Of Two Hedges
  • What Is Risk?
  • How To Find A Great Financial Advisor?
  • Is It Time To Find A New Financial Advisor?
  • 4 Steps To A More Secure Investment Portfolio For Your Retirement
  • Traditional Investing May Decrease Your Retirement Lifestyle
  • Year-End Tax Planning Can Help Generate High Return On Investment
  • Is Your 401(k) Plan A Failure?
  • Understanding Deflation
  • Tax Issues To Consider When Buying A Long-Term-Care Policy
  • Evaluating The Quality Of A Company's Earnings
  • Investing In Times Of Uncertainty And Risk: The Importance Of Diversification
  • 2001 Tax Relief Act Changes Education Planning
  • Yesterday's Great Companies
  • A Retirement Plan Primer After The 2001 Tax Act
  • Beware Of Common Home Repair Scams
  • Custodial Accounts: One Way To Make Gifts To Children
  • Estate Taxes To Be Reduced Then Repealed In 2010
  • Faulty IRA Conversions Can Lead To Tax Penalties
  • Many Individuals Pay Private Mortgage Insurance Beyond When It Is Necessary
  • Rethinking Estate Planning
  • Retirement Plan Contribution Limit Changes
  • Shopping For A Bank Account That Pays The Highest Possible Rate Of Interest
  • Early Retirement Incentives For Tenured Faculty Waives Fica Tax Payment
  • Do It Yourself Tax Preparers Watch Out: Tax Answers From IRS Centers Oftentimes Are Incorrect And/Or Insufficient
  • Your Medical File Report May Need A Check-Up
  • Five Tips For Preventing Thefts From Your Checking Account
  • Home Office Deductions: Hoops To Jump Through
  • Income Tax Effect On Single And Married Taxpayers
  • Income Tax Planning For Investments
  • Property Tax Challenges Should Not Be Overlooked
  • The IRS Will Follow Your Wealth To The Ends Of The Earth
  • When Do You Need Life Insurance
  • REITs: A Great Diversification Investment
  • Bank Loan Funds: A Great Fixed Income Investment As Interest Rates Rise
  • Estate Tax Will Be Reduced Gradually, Then Repealed in 2010



  • ©2017 Legend Financial Advisors, Inc.®. All rights reserved.