4.24 State and City Interest Generally Tax Exempt

Generally, you pay no tax on interest on bonds or notes of states, cities, counties, the District of Columbia, or a possession of the United States. This includes bonds or notes of port authorities, toll road commissions, utility services activities, community redevelopment agencies, and similar bodies created for public purposes. Bonds issued after June 30, 1983, must be in registered form for the interest to be tax exempt. Interest on federally guaranteed obligations is generally taxable, but see exceptions in 4.25.

Check with the issuer of the bond to verify the tax-exempt status of the interest.

Tax-exempt interest must be reported on your return.

If you are required to file a federal return, you must report the amount of your tax-exempt interest although it is not taxable. On Form 1040 and on Form 1040A, you list the tax-exempt interest on Line 8b. On Form 1040EZ, you write “TEI” and then the amount of tax-exempt interest to the right of the last word on Line 2, but do not include it in the taxable interest shown on Line 2.

Private activity bonds.

Interest on so-called private activity bonds is generally taxable (4.25), but there are certain exceptions. For example, interest on the following “qualified bonds” is tax exempt even if the bond may technically be in the category of private activity bonds: qualified student loan bonds; exempt facility bonds, including New York Liberty bonds, Gulf Opportunity Zone bonds, Midwestern disaster and Hurricane Ike area bonds, and enterprise zone facility bonds; qualified small issue bonds; qualified mortgage bonds and qualified veterans’ mortgage bonds; qualified redevelopment bonds; and qualified 501(c)(3) bonds issued by charitable organizations and hospitals. Check with the issuer for the tax status of a private activity bond.

AMT treatment.

Tax-exempt interest on qualified private activity bonds issued after August 7, 1986 and before 2009, or on bonds issued after 2010, is generally treated as a tax preference item subject to alternative minimum tax (AMT, 23.2), but there are exceptions. The AMT does not apply to interest on qualified 501(c)(3) bonds, New York Liberty bonds, Gulf Opportunity Zone bonds, Midwestern disaster and Hurricane Ike disaster area bonds, and exempt facility, qualified mortgage, and qualified veterans’ bonds issued after July 30, 2008.

The interest on any qualified bond issued in 2009 or 2010 is not subject to AMT.