Municipal Bonds (Munis)

Municipal bonds are issued by states, cities, counties, and other government entities to fund public projects.

Tax advantages

• Federal tax-exempt: Interest is typically exempt from federal income tax
• State tax-exempt: Often exempt from state tax if you live in the issuing state
• AMT consideration: Some private-activity munis may be subject to alternative minimum tax

Types

General Obligation (GO) bonds

Backed by the full taxing power of the issuer. Generally considered safer.

Revenue bonds

Backed by revenue from a specific project (toll road, hospital, airport). Risk depends on project success.

Tax-equivalent yield

To compare munis with taxable bonds:

Tax-equivalent yield = Muni yield ÷ (1 − marginal tax rate)

A 3% muni yield for someone in the 32% tax bracket = 4.41% taxable equivalent.

Who benefits most

Municipal bonds are most advantageous for investors in high tax brackets. For investors in lower brackets, the tax benefit may not offset the typically lower yields.