Question

Which of the following instruments, producing the same rate of interest income, offers the greatest potential overall tax advantage to an individual who lives in a state that has a high state tax rate

Certificate of deposit.

Corporate bond.

Municipal bond issued by the state in which the taxpayer is a resident.

Treasury bond.

Answer 1

Certificate of deposit enjoys some tax advantage while offering lower risk. Income from Corporate bonds and treasury bonds are taxable in the hands of taxpayer. Municipal bonds also enjoy tax advantage, however with higher risk.

If the taxpayer has high income tax bracket and lives in state with relatively high income tax rates, investing in municipal bonds will create high tax advantage than taxable bonds and CDs. However, if taxpayer is in state with lower tax rates, municipal bonds shall be avoided.

Hence, the correct answer is municipal bond issued by the state in which the taxpayer is a resident.