Written by:
Image
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades.

Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers. While there, Paul authored and edited thousands of financial research briefs, was published on Nasdaq. com, Yahoo Finance, and dozens of other prominent media outlets, and appeared as a guest expert at prominent radio shows and i...

View all posts
Updated August 12, 2020

What is Tax-Exempt Security?

Generally, tax-exempt securities are those whose interest, dividends or gains are free from federal income taxation.

How Does Tax-Exempt Security Work?

For example, let's assume that John purchases $1,000 of municipal bonds. The bonds pay 7% interest per year, or $70. Because municipal bonds are typically tax-exempt securities, John does not have to pay federal income tax on the $70 worth of interest income. He may also not have to pay state or local taxes on that income, depending on whether he lives in the municipality issuing the bonds.

Municipal bonds are the most common tax-exempt security, but mutual funds that invest in municipal bonds, U.S. savings bonds, or other tax-exempt securities can also receive tax-exempt status.

Why Does Tax-Exempt Security Matter?

Tax-exempt securities save investors money on taxes. Accordingly, tax-exempt securities can be very attractive, particularly to investors in high tax brackets. 

Tax-exempt securities also provide local governments and nonprofits (the most common issuers of tax-exempt securities) with lower borrowing rates. This in turn encourages governments and nonprofits to undertake new projects.

Considerable controversy exists regarding what sorts of securities should be tax exempt. Most of the time, an organization has to be registered under section 501(c)(3) of the Internal Revenue Code before it can issue tax-exempt securities. 

It is also important to note that even though a tax-exempt security may provide income or gains that are exempt from federal income taxes, the taxpayer or organization might still have to pay state, local, or other types of taxes (such as payroll taxes, sales taxes, or excise taxes).

Ask an Expert about Tax-Exempt Security
At InvestingAnswers, all of our content is verified for accuracy by Paul Tracy and our team of certified financial experts. We pride ourselves on quality, research, and transparency, and we value your feedback. Below you'll find answers to some of the most common reader questions about Tax-Exempt Security.
Be the first to ask a question

If you have a question about Tax-Exempt Security, then please ask Paul.

Ask a question

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 2 million monthly readers.

If you have a question about Tax-Exempt Security, then please ask Paul.

Ask a question Read more from Paul

Read this next

Don't Know a Financial Term?
Search our library of 4,000+ terms
Paul Tracy - profile
Ask an Expert about Tax-Exempt Security

By submitting this form you agree with our Privacy Policy

Share
close