Purchasing municipal bonds in your regular IRA, SEP, or §401(k) is a no-no. These accounts grow tax free and when withdrawals are made, the amount withdrawn is taxable. Thus, if you desire fixed income deposits obligations in a tax advantaged account consider taxable bonds or similar income securities.
Alternative Minimum Tax Considerations
Interest on municipal bonds is usually not included in income for regular federal income taxes. Interest earned on certain municipal bonds called "private activity bonds" is included in the calculation of alternative minimum tax (AMT). The AMT is a parallel tax system established to make sure that taxpayers pay a minimum amount of taxes. The intention of creating AMT was to prevent people from getting to many tax breaks, for example tax-free interest. The tax breaks are added back into income and cause some people lose tax breaks and pay taxes.
Effects of Tax-Free Interest on Taxability of Social Security
A percentage of social security benefits are taxable when other income besides social security benefits surpasses certain amounts. For this purpose, the amount of taxable social security benefits adds tax-exempt interest into the amount of other income received besides social security benefits to determine the amount of taxable social security benefits. Consequently, if you receive social security benefits, tax-free bonds could increase the amount of tax paid on social security benefits.
Effects of Tax-Free Interest on the Calculation of Earned Income Tax Credit
When a taxpayer is otherwise qualified to receive the earned income tax credit, the credit is lost completely when the taxpayer has more than $3,400 (2015) of "disqualified income." Disqualified Income generally is investment income like dividends, interest -income, and tax-exempt income. Thus, having municipal bonds interest in excess of $3,400 causes a taxpayer to lose the credit. However, an individual qualified for the earned income tax credit is in a lower tax bracket and an investment in municipal bonds would yield a lower after tax return as compared to taxable bonds.
A Bond Sale or Redemption
Selling a bonds before maturity or redemption has the same tax consequences as a taxable bond. Gains from sale are taxable. Losses are deducted from other gains; and losses in excess of gains are allowed up to $3,000, the remaining losses are carried over to future years.
Selling Bonds Purchased At a Discount
Buy Bonds in India acquired with "market discount", have special calculations then they are sold. The discount that accrued during the period maybe treated as ordinary income.
Mutual Funds
Some investors want professionals to manage a diversified portfolio of municipal bonds, to lower the default risk on any particular bond issue. There are certain mutual funds that invest in tax-free municipals and manage them.
We hope this article was helpful. This article is an example for purposes of illustration only and is intended as a general resource, not a recommendation.
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