Which statement correctly describes tax treatment of different bonds?

• A. Corporate bonds: interest taxed as ordinary income; Treasury bonds: interest taxed only at federal level; Municipal bonds: generally tax-exempt at federal level and also state tax-exempt if the investor resides in the issuer's state
• B. Corporate bonds: tax-exempt; Treasury bonds: tax-exempt; Municipal bonds: tax-deductible only
• C. Corporate bonds: tax-free; Treasury bonds: tax-free; Municipal bonds: taxable
• D. Corporate bonds: capital gains taxed; Treasury bonds: tax-free; Municipal bonds: tax-exempt at federal level but not state level

Answer: (A)

Bond interest is taxed differently depending on the issuer. Corporate bond interest is taxed as ordinary income at the federal level (and may be taxed by states). Interest from Treasury securities is subject to federal tax but is exempt from state and local taxes. Municipal bond interest is generally exempt from federal income tax, and if you live in the issuer’s state, it’s typically exempt from that state's income tax as well. So the statement that best fits is that corporate bonds are taxed as ordinary income, Treasury bonds are taxed at the federal level only, and municipal bonds are tax-exempt federally and often also state-exempt for in-state residents. The other options misstate one or more tax treatments, such as claiming all bonds are tax-exempt or calling corporate interest tax-free, or suggesting municipal bonds are taxable.