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All municipal bonds are first assessed for risks before a credit rating is given to them. Guarantee for municipal bonds is provided by the local government, a group of local governments or a subdivision of the local government. The risk of a municipal bond is decided based on the ability of the issuer to make complete payments on time.
Usually the interest earned from municipal bonds is exempt from state income tax as well as federal income tax. The state income tax is exempt only in the state where the municipal bond was issued. However, there are certain exceptions and some municipal bonds are taxable.
Municipal bond interest is taxable depending on the type of project the funds from the bond will be used in. For instance, if the bond is used to construct something for public welfare, then the interest from the bond will not be taxable. However, if the bond is used to construct or build something which will benefit just a few people, the interest from the bond is taxable. Just to assure you, the taxable status of a municipal bond is decided before the bond becomes available to public. This means that not all municipal bonds are tax exempt.
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