What is a 'Double Exempt'

The term double exempt refers to a type of tax benefit attached to certain bonds which allows the interest earned from the bonds to be exempt from being taxed as gross income from both federally and by state taxation. For example, municipal bonds, also called munis, are usually exempt from federal taxes and in some states they are also exempt from state taxes. 

BREAKING DOWN 'Double Exempt'

A  municipal bonds status as double exempt means earned interest is not subject to taxes on either the federal or state level. While muni earnings are exempt from federal taxes, they may be subject to state taxes. Most states do not tax residents on interest income from tax-exempt bonds issued within that state. These exempt bonds include those issues from agencies, cities, and other political entities. However, virtually all states tax individuals on interest from bonds issued by out-of-state municipalities or agencies.

Municipal bonds, including those for which the interest is not taxable at the state or local level, are attractive to taxpayers who wish to minimize or avoid taxes on their interest income. These securities often pay a commensurately lower interest rate than taxable issues such as corporate bonds

However, depending on the investor's tax bracket taxable products may sometimes be more beneficial to them. Double exempt bond income can be an alternative minimum tax (AMT) preference item in some cases. From a tax perspective, this treatment often makes bonds issued in one's home state more attractive than those issued out-of-state. Also, some interest from municipal securities is also exempt from local income tax in jurisdictions where such taxes apply, technically making them triple tax-exempt.

Limitations on Double Exempt

Although double exempt bonds sound like they are exempt from all tax, there are some limitations. In some cases, interest earned on the bonds will be subject to an alternative minimum tax (AMT), which is mostly a different form of federal taxation targeted explicitly towards private acuity bonds.

Also, not all municipal bonds are automatically exempt from federal, state, or local taxes. Investors should check before they buy or invest. Also, some experts caution against investing too heavily in home-state bonds only for the lure of the double exempt taxation status.

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