Triple tax free rule - tax exempt state bonds

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Buying municipal bonds within your own home state qualifies for the investment to be triple tax free. That means no federal, state or local taxation. Muni Bonds are normally tax exempt on the interest earned federally - at your ordinary income tax bracket. This rule or allowance is meant to promote investing within your local municipality.

Municipal bonds and notes are issued by state and local governments. These municipalities include:


States
Counties and Cities
Towns and Schools
Municipal Authorities

Interest payments on traditional municipal bonds are exempt from federal tax. They are subject to state and local tax.

Tax Free Yield

When looking to purchase muni bonds, a person should understand how tax exempt yields work. The higher the tax bracket, the higher the yield. If an investor is considering buying a 6% municipal bond at par and they are in the 28% tax bracket, the tax free yield would be higher than 6%. The formula is: Municipal stated rate or coupon divided by 100 minus the tax bracket.

The calculation would break down like this:

6% divided by 72 (100-28), which equals 8.33%. This means that to achieve a better return than this 6% coupon bond, you would need equal to or better than 8.33% in a taxable investment. A lower tax bracket would show a lower tax free yield.

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