As tax season revs up, traders could be on the hook for reporting – and paying – obligations on their tax-free municipal bonds. Traders are probably gathering the paperwork they should file their 2024 tax returns, that are due on April 15. It was a giant yr for income-generating investments , even because the Federal Reserve trimmed rates of interest 3 times. Which means traders are discovering themselves on the hook for taxes on curiosity revenue as their certificates of deposit, cash market funds and high-yield financial savings accounts supplied annual share yields exceeding 4%. Municipal bond traders aren’t essentially spared from tax-season hurdles even because the revenue from these points is usually freed from federal revenue taxes (and state taxes if the investor resides within the issuing state). When the Fed was on its rate-hiking cycle in 2022 and 2023, bond costs – together with munis – tumbled. Bond costs and yields transfer in reverse instructions. Traders who stepped in to purchase up a budget muni points bought a very good deal on the time, however they may very well be topic to reporting necessities and tax funds annually. “One of many guidelines with municipal bond reductions is that you need to decide up that unfold in revenue yearly, and it may be taxable even when it is coming from a tax-exempt bond,” mentioned Tim Steffen, licensed public accountant and director of superior planning, personal wealth administration at Baird. “This is not a problem in case you’re in a bond fund or a bond ETF, however in case you purchase particular person bonds, you’ve to pay attention to these items.” The de minimis rule When traders purchase municipal bonds at a reduction to their par worth – the quantity that the issuer will repay at maturity – tax penalties could come up. If this low cost is lower than 0.25% of the par worth, multiplied by the variety of years to maturity, then the low cost is taxed like a capital achieve . Which means it is topic to charges of 0%, 15% or 20%, relying on the taxable revenue of the investor. Nonetheless, if the low cost is the same as or higher than 0.25% of par worth, occasions the variety of years to maturity, then it’s handled like peculiar revenue . These charges may be as excessive as 37%. Contemplate an investor who buys a 10-year municipal bond with a par worth of $10,000, but it surely’s buying and selling at $9,500. The $500 low cost is what’s taxable. Most traders decide to pay the tax incrementally annually, however some could do it at maturity, in line with Cooper Howard, mounted revenue strategist on the Schwab Heart for Monetary Analysis. Traders ought to work with their tax skilled to search out out what works greatest for them. “If it is under par, that raises type of a yellow flag of ‘I gotta take a look at this a little bit additional,'” Howard mentioned. Different tax hiccups for munis Municipal bonds may current different tax surprises for traders. For starters, retirees will discover that their municipal bond revenue is counted towards their modified adjusted gross revenue – the calculation that is used to find out how a lot they pay in month-to-month premiums for Medicare Half B and prescription protection. In 2025, people who file tax returns with modified adjusted gross revenue that is $106,000 or much less ($212,000 or much less for joint filers) must pay month-to-month Half B premiums of $185. These with revenue exceeding these revenue thresholds must pay extra, with the best bracket of taxpayers with revenue exceeding $500,000 (or $750,000 for joint filers) on the hook for Half B premiums of $628.90 per 30 days. Traders who snap up taxable municipal bonds may also discover themselves on the hook for levies. Howard estimates that these points account for about 10% of muni bond market. They typically supply larger yields to compensate for the truth that their curiosity revenue is taxable on the state and federal ranges. “That element is listed within the providing assertion, and it ought to be upfront when the person buys the bond,” Howard mentioned, noting that taxable munis could make sense for traders in low tax brackets and for many who wish to maintain munis in tax-advantaged accounts like a person retirement account. “You may get a muni that is excessive credit score high quality, pays larger curiosity than comparable bonds, and also you’re sheltered from the revenue tax as a result of it is in an IRA,” he mentioned.