Thursday, May 15, 2014


Another entry on the list of clients who are screwed by the Tax Code – those who invest in tax-exempt bonds.

Interest on municipal bonds, and dividends from mutual funds that invest in municipal bonds, are exempt from federal income tax – right?  Well it ain’t necessarily so!

Tax-free income from state and local municipal bonds and municipal bond funds is included in the calculation of the taxable portion of Social Security and Railroad Retirement benefits.  Those of you who have been following this series know that tax-exempt municipal bond income can actually be taxed at a rate of 12.75% (taxpayers in 15% bracket) or 21.25% (those in 25% bracket). 

While tax-exempt income is not included in AMT, the additional taxable portion of Social Security and Railroad Retirement benefits that result from investments in municipal bonds is included, so, because of the variety of AGI-based reductions of deductions or credits, the effective tax rate on municipal income for those in these brackets can be even higher.  

Tax-free income from a category of municipal bonds known as “private activity bonds” is considered a “tax-preference” for purposes of calculating the dreaded Alternative Minimum Tax (AMT).  According to Wikepedia “a private activity bond is a bond issued by or on behalf of local or state government for the purpose of financing the project of a private user”.  If you are a victim of the dreaded AMT the interest from this type of bond could be taxed at a rate of from 26% to 35% (as explained in another previous entry in this series).

And income from tax-exempt bonds, of any category, could cause you to pay a higher premium for Medicare Part B and part D coverage.

As the Social Security Administration explains – “If you file your taxes as “married, filing jointly” and your MAGI {Modified Adjusted Gross Income – rdf} is greater than $170,000, you will pay higher premiums for your Part B and Medicare prescription drug coverage. If you file your taxes using a different status and your MAGI is greater than $85,000, you will pay higher premiums.”

Your MAGI is the total of your Adjusted Gross Income plus your tax-exempt interest.

The additional monthly payment goes from $42.00 to $230.80 for Part B and from $12.10 to $69.30 for Part D – depending on the amount of your MAGI and your filing status.


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