5.1.7.4. Types of Bond Funds
Some bond funds are more beneficial from a tax perspective than others. Tax-advantaged funds are suitable for investors with high tax rates. Note that even when interest is tax-exempt at the federal or state level, all capital gains distributions are subject to taxation at all levels (federal, state, and local).
The following table offers a breakdown of how interest is taxed for different bond funds.
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Tax Burden of Bond Funds |
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Taxable at this level? |
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Type of Fund |
Federal |
State |
Local |
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Corporate bond funds |
Yes |
Yes |
Yes |
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Agency-backed MBS and CMO funds |
Yes |
Yes |
Yes |
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Treasury funds |
Yes |
No |
No |
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Municipal bond funds |
No |
Maybe* |
Maybe* |
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* Maybe = Municipal bond funds may be taxable at the state and local levels, especially if the bonds were issued outside the investor’s state; income from some municipal bond funds also may be subject to the alternative minimum tax (AMT). |
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