What is a Tax-Exempt Bond?
A bond is a form of debt–a promise by the issuer to pay a specified sum of money (principal amount) at a date in the future (maturity date), along with periodic interest at a specified rate. Tax exempt bonds earn interest that is not included in the owner’s income for state or federal tax purposes. That is why bond owners favor them. Issuers favor tax-exempt bonds because they can usually borrow money at substantially lower interest rates. Who may issue tax-exempt bonds? The tax code allows only states or their political subdivisions to issue tax-exempt bonds. In the utility arena, a “political subdivision” includes municipal utilities, utility districts and joint action agencies comprised of such municipal utilities or districts. Tribal governments may also issue tax-exempt bonds to finance essential governmental functions, such as electric or water utilities. Because they are private entities, co ops and investor-owned utilities cannot themselves issue tax-exempt debt. However, co-o
There are wide variety of bonds available that fall into the tax-exempt bond category. The most commonly traded are municipal bonds (or munis) and Treasury securities. The munis are federal tax exempt and the Treasuries are mainly state and local tax exempt. It is important to be aware that your personal portfolio may mandate a portion of your interest be subject to alternative minimum tax. Munis are issued by some government entity, whether it be local or state. Tax-exempt bond instruments issued by municipalities are either general obligation bonds or revenue bonds. General obligation bonds are issued for any project within the confines of the local or state authority. These bonds are usually the safest, with the lowest risk attached. Consequently, their interest rate might be below that of the revenue bonds. Revenue bonds are issued for specific projects. Common projects are airport improvements, highway and transportation, hospitals, housing, local improvement and development (LIDS
