Intuit Academy Tax Practice Exam

What type of interest income is generally not taxed?

1. Interest income from corporate bonds

2. Interest income from municipal bonds

3. Interest from savings accounts

4. Interest from foreign banks

The correct answer is: Interest income from municipal bonds

Interest income from municipal bonds is generally not taxed at the federal level, which is a significant advantage compared to other types of interest income. Municipal bonds are issued by state and local governments to fund various projects, and the interest earned on these bonds is often exempt from federal income tax. This tax advantage makes municipal bonds an attractive investment choice for individuals in higher tax brackets. In contrast, interest income from corporate bonds, savings accounts, and foreign banks is subject to federal income tax. Corporate bonds typically yield higher interest rates, but that income is fully taxable. Interest earned from savings accounts is also taxable and reported on the individual's tax return. Lastly, interest from foreign banks may be subject to taxation as well, typically requiring reporting on a foreign income or financial account in addition to regular income reporting. Thus, the exemption of municipal bond interest from federal taxation is what sets it apart in this context.