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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.

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

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The Medicare surtax on investment income
If you're a high earner, an additional tax could apply to your investment income.

*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.

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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.