The first part of the equation is the interest income that a bond generates. Depending on the type of bond, it depends on who, if anyone, gets the taxes. Interest income is taxed at normal income rates, ie your tax bracket.
Holders of US Treasury bonds, notes and bills, and government agency bonds are taxed on interest at the federal level. However, such interest income is generally exempt from state and local taxes. This could be a big win for investors in high-tax jurisdictions.
Corporate bonds and mortgage-backed securities aren’t so lucky. Owning a bond issued by Walmart or Fannie Mae means that the bondholder must pay federal, state, and local taxes, if any, on the interest.
Municipal bonds are issued by states, counties, cities, and other government agencies. Interest on these bonds is generally not subject to federal income tax. Interest may also be exempt from state or local income taxes if the bond is issued by your home state. So if you live in Texas and own a Muni bond issued by the Texan government, the interest is tax-free. However, municipal bonds issued by another state or city are taxable on your state or local income tax return.
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