What is Tax-Exempt Interest?
Tax-Exempt Interest Example
For example, let's assume that John Doe purchases a municipal bond. The bond pays 5% interest per year, or $50 for every $1,000 John Doe invests. That $50 is income to John, which is normally taxable. However, because municipal bonds are tax-free securities, John's interest is tax-exempt.
Taxpayers are required to report the amount of tax-exempt interest they receive on Form 1040 or Form 1040A. Borrowers that pay more than $10 of tax-exempt interest must report those payments to the IRS and the lenders via Form 1099-INT.
In some cases, the amount of tax-exempt interest aearns can limit the taxpayer's qualification for certain other tax breaks.
Why Tax-Exempt Interest Matters
One of the largest advantages of investing in is that the interest is usually exempt from federal and is also exempt from most state and local if the investor lives in the state or municipality issuing the debt (capital gains on are taxable, however). Although investors subject to the alternative minimum tax may be required to pay on interest, tax-exempt interest means that many investors in high federal-tax brackets particularly benefit from investing in .
The lower yields associated withthat pay tax-exempt interest also provide borrowers with borrowing rates that may be more attractive than what is available through other means. This in turn encourages the local governments to undertake new projects.
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