Securities Industry Essentials (SIE) ExamUnderstanding Products and Their RisksEasy
A client is seeking an investment that provides tax-advantaged income at the federal level. They are particularly interested in a bond issued by a local municipality to fund a new public school. Which of the following terms best describes the income generated by this investment?
- ATax-exempt income
- BTax-deferred income
- CTaxable income
- DCapital gains income
Show answer & explanationAnswer & explanation
Correct answer: A. Tax-exempt income
Interest income from municipal bonds (issued by state and local governments) is generally exempt from federal income tax. If the bond is purchased by a resident of the issuing state, it may also be exempt from state and local taxes.
Why the other options are wrong
- B. Tax-deferred income means taxes are paid later, not that the income is exempt.
- C. This income is not taxable at the federal level.
- D. Capital gains are profits from selling the bond, not the interest income it generates.
Municipal Bond Tax Exemption
Interest income from municipal bonds is generally exempt from federal income tax, and often from state and local taxes if the bondholder resides in the issuing state.
- Issued by state and local governments.
- Used to finance public projects (schools, roads).
- Interest is federally tax-exempt; sometimes triple tax-exempt.
Memory trick: Muni Money Means Minimal Taxes.