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Difficulty: MediumGovernment, Municipal, and Corporate Bonds

An investor residing in Ohio earns interest income from holding U.S. Treasury bonds, corporate bonds issued by a national retailer, and municipal bonds issued by the city of Dallas, Texas. How is the interest income derived specifically from the U.S. Treasury bonds treated for income tax purposes?

  1. Exempt from state and local income taxes, but fully subject to federal income tax.Answer
  2. B
    Exempt from federal income tax, but fully subject to state and local income taxes.
  3. C
    Fully exempt from federal, state, and local income taxes due to being backed by the U.S. government.
  4. D
    Fully subject to federal, state, and local income taxes, similar to corporate bond interest.

Answer

Interest income from U.S. Treasury bonds is exempt from state and local income taxes, but fully subject to federal income tax.
Interest income on direct obligations of the U.S. government (Treasury bills, notes, and bonds) is subject to federal income tax, but it is explicitly exempt from state and local income taxes in all states.

Step-by-Step Solution

1
Identify the issuer of the fixed-income security in question.
The security is a U.S. Treasury bond issued by the federal government.
Tax rules differ significantly among Treasury, Municipal, and Corporate debt obligations.
2
Apply federal tax law regarding U.S. government debt obligations.
Direct obligations of the U.S. government generate interest income that is taxable at the federal level but immune from state and local taxation.
Federal law prohibits state and local governments from taxing interest paid on direct U.S. Treasury debt.

Key Concept

Taxability of U.S. Treasury Securities
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Topics

Government, Municipal, and Corporate Bonds

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