Question

A tax-exempt municipal bond pays 5.4% coupon interest annually while a similar taxable bond is paying 7.5% annually. Taxpayers in the _____ % marginal tax bracket and above would be better off investing in the tax-exempt bond.

b) 15

d) 28

a) 10

c) 25

Answer 1

ANSWER TO QUESTION

A tax-exempt municipal bond pays 5.4% coupon interest annually while a similar taxable bond is paying 7.5% annually. Taxpayers in the 28 % marginal tax bracket and above would be better off investing in the tax-exempt bond.

The reason is if he has invested in Taxable bonds and his marginal tax bracket is less than 28%, the net receipt after adjustment of tax in comparison to tax exempt municipal bond is always higher. For example if tax payer has $100,000 to invest. Investing the amount in Tax exempt bonds, net receipt would be $5,400. if he invest the same amount in Taxable bonds and is in the 28% tax bracket, in that case net receipt after adjustment of tax would be $5,400 (i.e. $7,500 - $2,100). Therefore if the tax payer is in 28% marginal tax bracket and above he would better invest in tax exempt bonds.