This post is designed to provide the reader with general information concerning what constitutes a tax-exempt security and how it is treated for tax purposes. Please keep in mind that this information is being provided for informational purposes only and is not designed to be complete in all material respects. Thus, it should not be relied upon as providing legal or investment advice. If you have any questions concerning this post or its contents, you should seek a qualified professional.
A tax exempt security is an investment vehicle whose interest is exempt from taxation by federal, state, and/or local authorities. It is generally referred to as a municipal bond regardless of whether it was issued by a state government or agency or by a county, town or other political district. The “bond” is backed by the full faith and credit or the issuer or by anticipated revenues of the issuing authority. Interest income earned from the tax-exempt security is free from federal income taxation as well as from taxation in the jurisdiction where the bond has been issued.
Mutual funds that invest in exclusively tax exempt securities confer the same tax benefits of their shareholders. However, as set forth above, while a fund’s dividends would be entirely tax-exempt on a shareholders federal tax return, they would be free from state income tax only in proportion to the amount of interest income derived from the taxpayer’s home state.