32.4 Tax-Exempt Bond Funds

Dividends from a bond fund that represent tax-exempt interest earned by the fund are not subject to regular income tax, but capital gain distributions are taxable. The exempt-interest dividends are shown by the fund in Box 10 of Form 1099-DIV. You report exempt-interest dividends along with your other tax-exempt interest on Line 8b of Form 1040 or of Form 1040A. The amount on Line 8b is not taxable, but if you receive Social Security benefits, the amount may affect the amount of taxable benefits (34.3). If part of the exempt-interest dividends are attributable to private activity bonds, that amount may be a preference item subject to alternative minimum tax (AMT) (23.3). The amount subject to AMT is shown in Box 11 of Form 1099-DIV.

Capital gain distributions are shown on Form 1099-DIV and must be reported on your return; see Table 32-1.

When you redeem your shares in a tax-exempt bond fund or exchange the fund shares for other shares in a different fund, you realize taxable capital gain or deductible loss.

If you received exempt-interest dividends on mutual-fund shares held for six months or less and sold those shares at a loss, the amount of your loss is reduced by the exempt-interest dividend. To reflect this adjustment, on Part I(short-term gains and losses) of Form 8949, you increase the sales price in column(e) by the exempt-interest dividend.