Series 7 practice questioneasyTax Implications — Municipal Bond Taxation
Interest on municipal bonds is generally exempt from:
- AState income tax only
- BFederal income tax✓ Correct answer
- CBoth federal and state income tax in all states
- DCapital gains tax on the bond's appreciation
Explanation
Why B — Federal income tax
Interest on municipal bonds is exempt from federal income tax under IRC Section 103. State tax treatment varies — most states also exempt interest on bonds issued within the investor's state of residence ("in-state" bonds) but may tax interest on out-of-state municipal bonds. Capital gains from selling municipal bonds at a profit are still subject to federal capital gains tax.
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