Bonds are available in both taxable and tax-exempt formats and there are tax concepts to consider when a person is investing in bonds. Each type of bond, whether tax-exempt or not, has different tax aspects. Tax-exempt municipal bonds and taxable bonds are discussed, explaining how some of the tax rules work for these investments and their investment yields.
Why to Invest in Municipal Bonds?
When purchasing tax-exempt municipal bonds at face value or par, there are no instant tax consequences. When the bonds in India is acquired between interest payment dates, the buyer pays the seller interest that has accrued since the last payment date. The interest paid in advance to the seller is treated as the cost of the investment and is treated basically as a return of some the initial investment when the interest is paid. You can Buy Bonds Online India from Bonds India
Bond Premium Amortization
When tax-exempt Local bonds are purchased at a premium, the premium is amortized for the duration of the bond term. The effect of this is to decrease the cost of the investment in the bond on a pro rata basis. Thus, holding the bond to maturity means no loss recognized when the bond is paid off.
Interest Excluded From Taxable Income
Normally, tax-exempt municipal bond interest is not added to income for tax purposes (although, the interest may be taxable under alternative minimum tax rules). Also note, municipal bonds in India usually pay lower interest rates as compared to similar bonds that are taxable.
When comparing taxable investments to tax-free bonds investments, the amount of interest included in income is not the most important issue. What is important is the after-tax yield. For tax-exempt municipal bonds, the after-tax yield is usually equivalent to the pre-tax yield. On the other hand, a taxable bonds India after-tax yield will be based on the amount of interest remaining after deducting the corresponding amount of income tax expense associated with the interest earned on a taxable bond.
The after tax return of a taxable bond depends on a person's effective tax bracket. In general, tax-free bonds are more appealing to taxpayers in higher brackets; the benefit of not including interest earned in their taxable income is greater. In contrast for taxpayers in lower brackets, the tax benefit is less substantial. Even though municipal bond interest is not taxable, the amount of tax-exempt interest is reported on the return. Tax-free interest is used to calculate the amount social security benefits that are taxable. Tax-free interest also affects the computation of alternative minimum tax and the earned income credit.
Tax-Free Interest is excluded from 3.8% NIIT
Tax-exempt municipal bonds interest is also exempt from the 3.8% net investment income tax (NIIT). The NIIT is compulsory on the investment income of individuals whose adjusted gross (AGI) is in excess of:
· $250,000 for filing status Married Filing Joint and Qualifying Widower,
· $125,000 for filing status Married Filing Separate, and
· $200,000 filing status Single and Head of Household.
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