The administration has stated that it intends to raise tax rates on people with incomes in the highest tax brackets in order to finance programs such as health-care reform.
The current top federal income tax rate of 35% is low by historical standards but is scheduled to revert to its original 39.6% rate after 2010. Meanwhile, the national debt is $11 trillion and growing, and the federal government is facing more than $40 trillion in unfunded entitlement obligations for Medicare and Social Security.
When you consider these staggering figures plus the hundreds of billions of dollars that the government is borrowing this year to help stimulate the economy, it becomes difficult to imagine a future in which tax rates will not be significantly higher.
Fortunately, municipal bonds offer an opportunity to earn an income that may be free of federal income tax.
Breaking the Bonds of Taxes
Municipal bonds are sold by state and local governments. Some munis are designed to raise immediate capital to cover expenses and are backed by the taxing power of the issuing government. Revenue bonds are issued to help fund infrastructure projects and are supported by the income the projects generate. Municipal bonds tend to have low default rates.
Muni bonds offer a potential source of tax-free income that tends to be more valuable to those in higher tax brackets. The interest on municipal bonds is typically free of federal income tax. As a result, munis tend to pay lower interest rates than taxable bonds. Thus, the tax benefits from a municipal bond are partially determined by your income level.
The principal value of bonds will fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Bond interest paid by a municipality outside the state in which you reside could be subject to state and local income taxes. If you sell a municipal bond at a profit, you could incur capital gains taxes. In some cases, municipal bond interest could be subject to the federal alternative minimum tax.
Although no one is sure when changes to the tax code may be made in the future, higher taxes may be inevitable. Call today to discuss strategies that may help lower your tax burden with municipal bonds.
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