Congress has talked in recent years about repealing the favorable tax treatment afforded to investments in municipal bonds ("munis"), but so far munis have retained their tax advantages, and they remain an attractive option, particularly for upper-income investors.
What's so appealing about munis? Here are four key tax benefits:
1. Muni interest is exempt from federal income tax. For example, if you're in the 25% tax bracket and you earn 6% interest on a taxable bond, you normally realize only a 4.5% after-tax return. With munis, there's no federal tax erosion.
2. Muni interest is exempt from state income tax if the bonds are issued by an authority within the state where you live. This also can increase the after-tax return on some munis.
3. Muni interest generally doesn't increase your adjusted gross income, or AGI. Because AGI is used to determine other taxes and tax breaks, having less of it could be an advantage.
4. Muni interest doesn't trigger the new 3.8% Medicare surtax. This surtax applies to the lesser of your net investment income (NII) or your modified adjusted gross income (MAGI) above $200,000 for single filers and $250,000 for joint filers. But munis don't count as NII and won't raise your MAGI, either.
Conversely, note that munis may trigger or increase tax on Social Security benefits for some retirees.
Of course, taxes aren't the only consideration in making investment decisions. But munis certainly have their advantages at a time when taxes are rising.
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