Series 7 practice questionmediumTax Implications — Municipal Bond Taxation
An investor who is a resident of New York purchases a California municipal bond. The interest income is:
- AExempt from both federal and New York state income tax
- BExempt from federal income tax but subject to New York state income tax✓ Correct answer
- CSubject to both federal and New York state income tax
- DExempt from federal income tax but subject to California state income tax
Explanation
Why B — Exempt from federal income tax but subject to New York state income tax
Municipal bond interest is exempt from federal income tax regardless of the state of issuance. However, most states only exempt interest on bonds issued within the investor's home state. Since this New York resident holds a California bond, the interest is subject to New York state income tax. This is why investors often prefer in-state municipal bonds for maximum tax benefit.
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