An older woman is laughing.
Understanding investment types

How government bonds are taxed

Whether they're issued at the federal, state, or local level, all government bonds have some sort of tax exemption.
4 minute read

Points to know

  • Bonds issued by federal governments may be exempt from state and local taxes.
  • Bonds issued by state or local governments may be exempt from federal, state, or local taxes.

Taxation of federal government bonds

Income from bonds issued by the federal government and its agencies, including Treasury securities, is generally exempt from state and local taxes.

If you own a bond, mutual fund or ETF (exchange-traded fund), you'll need to calculate the amount of income you earned from the fund's government bond holdings (if any) in order to take advantage of this exemption when you file your taxes—it won't be reflected on the tax forms issued by your investment company.

See information on income distributions from government bonds in Vanguard funds 

Bond

A debt security (IOU) issued by a corporation, government, or government agency in exchange for the money the bondholder lends it. In most instances, the issuer agrees to pay back the loan by a specific date and make regular interest payments until that date.

Mutual fund

A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.

ETF (exchange-traded fund)

An investment with characteristics of both mutual funds and individual stocks. Many ETFs track an index, a commodity, or a basket of assets. Unlike mutual funds, ETFs can be traded throughout the day. ETFs often have lower expense ratios but must be purchased and sold through a broker, which means you may incur commissions.

Taxation of municipal bonds

Income from bonds issued by state, city, and local governments (municipal bonds, or munis) is generally free from federal taxes.* You will, however, have to report this income when filing your taxes.

Municipal bond income is also usually free from state tax in the state where the bond was issued. However, keep in mind that:

  • Some states do tax interest on their own bonds.
  • Some states don't tax interest on municipal bonds from any state.
  • Sometimes a state that usually taxes interest on municipal bonds will exempt specific bonds at the time it issues them.

Depending on the laws where you live, income from municipal bonds also may be exempt from local taxes. Talk to a tax advisor for more information about the rules in your state.

Private activity bonds

Private activity bonds are municipal bonds that are issued to raise money for a private project (as opposed to a project for the good of the public). These bonds are exempt from federal taxes under the regular income tax system, but subject to tax under the alternative minimum tax system.

If you invest in municipal bonds through a bond fund, income from private activity bonds, if any, will be reported to you in Box 11 of your 1099-DIV.

See more about tax forms

Saving for retirement or college?

Take advantage of tax breaks just for you! See guidance that can help you make a plan, solidify your strategy, and choose your investments.

Start with your goals

Already know what you want?

From mutual funds and ETFs to stocks and bonds, find all the investments you're looking for, all in one place.

Find investment products

Get more from Vanguard. Call 855-850-6972 to speak with an investment professional.

Explore advice

*Although the income from a municipal bond fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Vanguard's advice services are provided by Vanguard Advisers, Inc. ("VAI"), a registered investment advisor, or by Vanguard National Trust Company ("VNTC"), a federally chartered, limited-purpose trust company.

The services provided to clients will vary based upon the service selected, including management, fees, eligibility, and access to an advisor. Find VAI's Form CRS and each program's advisory brochure here for an overview.

VAI and VNTC are subsidiaries of The Vanguard Group, Inc., and affiliates of Vanguard Marketing Corporation. Neither VAI, VNTC, nor its affiliates guarantee profits or protection from losses.

Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice. We recommend you consult a tax and/or legal adviser about your individual situation.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.