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Difficulty: EasyGovernment, Municipal, and Corporate Bonds

An investor residing in New York purchases newly issued U.S. Treasury bills. Which of the following statements correctly describes the taxation of the interest income earned from these securities?

  1. The interest income is subject to federal income tax, but exempt from state and local income taxes.Answer
  2. B
    The interest income is exempt from federal income tax, but subject to state and local income taxes.
  3. C
    The interest income is fully exempt from federal, state, and local income taxes.
  4. D
    The interest income is fully subject to federal, state, and local income taxes.

Answer

Interest income from U.S. Treasury bills is subject to federal income tax, but exempt from state and local income taxes.
Interest earned on direct U.S. Treasury debt obligations, such as Treasury bills, is subject to federal income tax, but carries a statutory exemption from state and local income taxes regardless of the investor's state of residence.

Step-by-Step Solution

1
Identify the type of issuer and debt instrument.
The instrument is a U.S. Treasury bill, issued by the U.S. federal government.
Taxability rules for fixed-income securities depend fundamentally on whether the issuer is corporate, municipal, or federal.
2
Apply federal debt taxability rules.
Direct obligations of the U.S. government (Treasury bills, notes, and bonds) are taxable at the federal level, but exempt from state and local income taxes.
Federal law prohibits state and local municipalities from taxing interest paid on direct U.S. federal government debt obligations.

Key Concept

Tax Treatment of U.S. Government Debt Securities
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Topics

Government, Municipal, and Corporate Bonds

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