what is tax exempt interest 
tax exempt interest is interest income that is not subject to federal income tax in some cases the amount of tax exempt interest a taxpayer earns can limit the taxpayer s qualification for certain other tax breaks the most common sources of tax exempt interest come from municipal bonds or income producing assets inside of roth retirement accounts tax exempt interest explainedtax exempt interest can be somewhat of a misnomer as it may still be taxed at the state or local levels it may also be subject to the alternative minimum tax amt furthermore capital gains on tax exempt investments are still taxable only the interest on these investments is tax exempt the most common way to earn interest that is tax exempt at the state and local levels in addition to the federal level is for an investor to purchase a municipal bond issued in his or her state or locality of residence municipal bonds are one of the most common types of investments that pay tax exempt interest but while interest may be tax exempt at the federal level it may still be taxed at the state level for example a california resident who buys a new york municipal bond would pay california income tax on that interest these tax laws however vary by state for instance some states such as wisconsin and illinois tax interest earned on most muni bonds including their own while states such as california and arizona exempt interest from taxes if the investor resides in their states utah is an example of a state that exempts interest on out of state bonds as long as that state does not impose a tax on bonds issued by utah treasury securities issued by the u s government pay interest that is tax exempt at the state and local levels but not the federal level triple tax exempt is a way of describing an investment usually a municipal bond which features interest payments exempt from taxes at the municipal state and federal levels state and local taxation of interestaccording to the internal revenue service irs interest on a state or local government obligation may be tax exempt even if the obligation is not a bond for example interest on a debt evidenced only by an ordinary written agreement of purchase and sale may be tax exempt also interest paid by an insurer on default by the state or political subdivision may be tax exempt mutual funds that hold a mix of stocks and municipal bonds will have the portion of earnings derived from the bonds tax exempt under federal income tax guidelines and possibly exempt from state taxes depending on the location from which the bonds originated and or the taxpayer s state of residence impact on adjusted gross income agi since tax exempt interest is not subject to income taxes it is not included in the calculation of adjusted gross income agi for taxation purposes issuers or lenders that pay more than 10 in tax exempt interest must report the interest income to both taxpayers and the irs on form 1099 int taxpayers or borrowers in turn must report this tax exempt interest on form 1040 the amount received as tax exempt interest is used by the irs to determine what amount of the taxpayer s social security benefits is taxable 