Remember how we said that the tax treatment of an ETF is determined by the assets it holds? This is also true of the monthly interest payments bond ETFs make to their investors. Depending on the bonds they hold, some funds can avoid paying federal or even state taxes entirely.
Interest payments from sovereign bond ETFs that contain U.S. Treasurys are also exempt from state and local income taxes because U.S. Treasurys are tax-free at the state and local level. They are, nonetheless, liable to federal taxes.
- Municipal Bond ETFs are tax-free at the federal level and may be tax-free at the state and local level.
Most muni bonds are tax-free in the United States, and they’re generally tax-free in the issuing state and/or city. As a result, interest payments from a municipal bond ETF are tax-free on a federal level. If you live in the same state or city as the bonds held by the muni bond ETF, you may be exempt from local and state taxes.
Some or all of the bonds in a broad-market bond ETF’s portfolio may pay tax-free interest. The type of income produced by each bond will be disclosed on the fund’s 1099-DIV form.
Also, keep in mind that interest payments are the only ones that are excluded. Investors in bond ETFs are still responsible for any taxes due on capital gains distributions, or profits earned from the sale of their shares.
Are there any ETFs that are tax-free?
- Year-to-date through October 7, tax-free municipal bond ETFs have received $16.4 billion in net inflows, up from $14.6 billion for the entire year of 2020.
- The two largest municipal bond ETFs are iShares National Muni Bond ETF (MUB) and Vanguard Tax-Exempt Bond ETF (VTEB), however there are also several significant index-based ETFs that focus on higher-yielding assets in the sub-category that can be utilized to improve income in an asset allocation plan.
- PIMCO has just announced the launch of a core-plus actively managed municipal bond ETF, which includes some speculative-grade bonds.
Are municipal bonds tax-free?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
Is there an ETF for municipal bonds?
Municipal bond ETFs are exchange-traded funds that invest in municipal bonds. A local government or territory, or their agencies, issues these bonds. The fact that interest income is deducted from gross income for federal income tax purposes is one of the most appealing aspects of municipal bonds.
Which bonds are completely tax-free?
Municipalities, like almost anything else related to taxes, can be confusing. The tax-exempt status of a bond only pertains to the interest it pays; any rises in the bond’s value are taxed if and when it is sold. When you sell shares in a municipal bond mutual fund, you may owe taxes.
In addition, depending on how the revenues will be used, certain munis may be subject to federal income tax. Unless specifically exempted, a bond that finances a project that provides a significant benefit to private interests is taxable at the federal level. A new football stadium, for example, may fulfill a local public purpose yet provide minimal benefit to federal taxpayers. As a reason, a muni bond used to fund it is known as a private-purpose bond. Housing, student loans, industrial development, and airports are examples of public projects whose bonds may be federally taxable.
Despite the fact that such bonds are subject to federal taxation, they can nonetheless provide some benefits. They may be exempt from state or local taxes, for example. And you might find that the yields on these taxable municipal bonds are closer to corporate bonds than tax-free bonds.
The tax position of agencies and GSEs (government-sponsored enterprises) varies. Ginnie Mae, Fannie Mae, and Freddie Mac bonds pay interest that is fully taxable at the federal, state, and local levels. Other GSE bonds, such as those issued by the Federal Farm Credit Banks, Federal Home Loan Banks, and the Resolution Funding Corp. (REFCO), are taxed at the federal level but not at the state or municipal level. Verify the issuer’s tax status before purchasing an agency bond.
Is municipal bond interest taxable?
Residents of the issuing state are generally excluded from federal and state taxes on income earned from municipal bonds. While interest income is tax-free, any capital gains delivered to the investor are taxable. The Federal Alternative Minimum Tax may apply to some investors’ earnings (AMT).
In Michigan, are municipal bonds taxable?
INTEREST INCOME OBTAINED FROM BONDS ISSUED BY THE COMMONWEALTH OF PUERTO RICO OR ITS AUTHORITY IS TAXABLE.
RAB-88-29. This Bulletin addresses the taxability of interest income earned by a Michigan resident on bonds issued by the Commonwealth of Puerto Rico or its authority for Michigan Individual Income Tax and Intangibles Tax purposes.
The federal government regulates the taxability of income from these bonds. In most cases, this income is tax-free at the federal, state, and municipal levels. The statute in question is 48 U.S.C.A. 745, which states:
“All bonds issued by the Government of Puerto Rico, or by its authority, shall be exempt from taxation by the United States Government, the Government of Puerto Rico, or any political or municipal subdivision thereof, or by any State, Territory, or possession, or by any county, municipality, or other municipal subdivision of any State, Territory, or possession of the United States, or by the District of Columbia.”
If a doubt about the taxability of a bond issued by the Government of Puerto Rico or its authority arises, the Department of Treasury will follow the Internal Revenue Service’s decision. Income from a bond may be liable to Michigan Individual Income Tax if the Internal Revenue Service deems that it is taxable for federal tax purposes.
In Canada, are municipal bonds tax-free?
Municipal bonds are among the least well-known government securities in Canada, but they also happen to be among the highest-yielding and safest.
Some have excellent AAA ratings, which are nearly non-existent in the corporate market; all have yield premiums over their home provinces’ bonds; and none have defaulted since the 1930s, according to bond raters and investment bankers.
Despite their merits, “Munis” are obscure. According to Stephen Ogilvie, head of Standard & Poor’s Corp.’s municipal bond finance department in Toronto, they account for around 2% of the SC universe bond total return index, Canada’s leading bond index. Institutions often buy the offerings, while underwriters frequently reserve allotments for retail clients.
Munis are uncommon for the same reason that they are appealing, according to Ogilvie: “The reason for the lack of depth in the Canadian municipal bond market as there is in the United States is that Canadian municipalities are debt averse.” Their foreign counterparts, especially those in the United States, borrow significantly more.”
In addition, he points out that, unlike in the United States, where municipal bonds are exempt from certain income taxes, interest on Canadian munis is taxed as ordinary income, just like any other bond. In addition, there is no particular tax structure in place in Canada to provide a tax-free market for municipal bonds.
The traditional culprits in municipal bond purchases are pension funds and life insurance corporations. Because most of the issues are small, thinly traded, and carry premiums for their lack of liquidity, they frequently hold them to maturity. According to an investment banker who works with these bonds, the liquidity premium is usually baked into each offering as a one- or two-basis-point increase in yield. The market may further discount the notes, adding two to six basis points to the built-in premium. However, if you try to sell the majority of the issues, the yield premium you obtained as a buyer will be forfeited to the next bidder, who will be looking for his or her own “illiquidity discount.”
As a result, Canadian munis are keeper species. They also provide good incentives. For example, the Municipal Finance Authority of British Columbia, which manages debt offerings for the province’s municipalities and communities, recently issued a 10-year bond with a 4.338 percent yield to maturity due Oct. 31, 2016. This translates to a yield premium of 31.5 basis points over a June 2015 Canada bond and three basis points over a March 2016 Ontario bond. The entire issue size was $715 million, which included a previous debt issuance. The issuance, which is rated AAA by Moody’s Investors Service Inc. (AA+ by Standard & Poor’s), is an example of the yield and quality offered by the municipal bond market, which rarely offers issues below investment grade.
In contrast to the corporate bond market, where AAA ratings on straight corporate credits are rarely, if ever, issued, a number of Canadian municipalities, including Saskatoon and London, Mississauga, and the regional municipalities of Durham, Peel, and Halton in Ontario, offer a number of AAA credits. Dominion Bond Rating Service Ltd. ranks Toronto’s credit at AA (low), Winnipeg at AA (high), Calgary and Edmonton at AA (high), and Montreal at A. (high).
Although raters disagree on specific grades, all munis that are rated are investment-grade, according to Paul Judson, DBRS’s vice president for Canadian munis.
And, while all three types of bonds are financed by tax revenue that reflects the strength of their respective economies, munis have portfolio values that are quite different from federal and provincial bonds, according to Judson: “The credit quality of municipal bonds rests on the issuers’ taxing powers.” Property taxes, which are more predictable than income tax flows, are available to them. Property taxes are less affected by economic cycles than income taxes, which are used by higher levels of government.”
Furthermore, governments have the authority to seize property if owners do not pay their property taxes, according to Judson. Municipalities also have more leeway in raising taxes than other levels of government. He claims that when the economics of western provinces grow stronger, the security of munis grows.
Munis come in a variety of shapes and sizes. The simplest to analyze is the basic “bullet” bond, which has only one due date. For example, a $100 million City of Toronto issue due September 27, 2016 was priced at issue to yield 4.5 percent, saving 43.3 basis points over a comparable Canada bond. There are also “amortizing” bonds, which are issued in ten-bond series with consecutive due dates. Amortizing bonds can divide a $100 million issuance — a reasonable sum in the munis market — into ten $10 million bonds, each due one year apart and too little to support much of an aftermarket.
“Taking on less liquidity is rewarded with a higher yield,” says Dave Burner, senior vice president, government finance at National Bank Financial Ltd. in Toronto.
“For a time-specific return, municipal bonds are acceptable for a buy-and-hold strategy,” Judson says. “The concern is whether the yield boost is sufficient to cover the illiquidity.”
“How can you go wrong with a buy-and-hold strategy for high-quality munis, picking up a yield that can be up to 10% more than the yield on a federal bond?” enquires Derek Moran, president of Kelowna, British Columbia-based financial planning firm Smarter Financial Planning Ltd. “If you’re looking for a high yield, munis are a good option, especially if you buy at issue and hold until maturity.” That isn’t a means to make a profit, but it is a terrific way to produce consistent revenue.” IE
Is PZA tax exempt?
Description of the PZA Fund PZA is a stock that tracks an index of investment-grade, tax-exempt debt publicly issued by a US state with at least 15 years to maturity.