It’s income tax refund season!
Last week we discussed three smart ways to save or invest your refund. But this week, we’re talking about a slightly more exciting tax topic: how to earn tax-free income.
I’d wager that a lot of people are looking for legal ways to minimize their future tax liability right now. After all, as I mentioned last week, many taxpayers are getting an unpleasant surprise in the form of slightly lower average refunds than last year.
Those low refunds aren’t entirely a bad thing; they’re partially a result of lower withholding under the new income bracket system. But they’re also partially a result of popular deductions, like the state and local tax deduction, being capped.
If you got burned by the IRS or your state tax authority this year, you’d probably benefit from some of the tax-free income investment strategies we’ll discuss today.
And when I say “tax-free income,” I don’t mean “tax-deferred income,” “federally tax-free income,” or “state tax-free income.” I mean totally tax-free income — permanently exempt from federal and state taxes.
Yes, it’s a real thing. Let’s look at three ways to earn it.
Municipal Bonds from Non-State U.S. Territories
Non-state U.S. territories like Puerto Rico, Guam, and the Virgin Islands have a pretty strange and complicated legal status. Their residents are U.S. citizens, but they have no congressional vote, can’t vote in presidential elections, and generally don’t pay federal income taxes.
But there’s an upside to the legal limbo these three territories are in: Interest from their municipal bonds is exempt from federal and state taxes!
Puerto Rico is by far the largest of these three non-state territories in terms of both population and GDP, and it’s worth discussing on its own.
I know what you’re thinking: The island might not seem like a good place to invest. Yes, it went bankrupt in 2017. Yes, it was devastated by Hurricane Maria later that same year.
But Puerto Rico survived both of these catastrophes, and it’s starting to recover. In the process, it’s starting to attract municipal bond investors.
PIMCO actually increased its Puerto Rican municipal bond holdings nearly tenfold after the hurricane. Other large custodians like AllianceBernstein and Massachusetts Financial Services Co. have also grown their Puerto Rican bond portfolios in the last two years.
If the triple-tax-exempt status isn’t enough of an incentive to invest in Puerto Rican bonds, check out the yields. The territory’s bad financial reputation has pushed down bond prices, creating yields as high as 6.7% at the time of writing. Plus, buying them is a good deed — you’re providing infrastructure funding to an island that really, really needs it.
Untaxed State Municipal Bonds
Do you live in Washington, Texas, Florida, Alaska, South Dakota, Wyoming, Nevada, or the District of Columbia?
If so, congratulations — all municipal bond interest is free of federal and state taxes for you!
All municipal bonds are federally tax-exempt no matter where you live or where the bond was issued. And the states listed above have no personal income taxes. The nation’s capital does have an income tax, but it chooses not to tax any municipal bond interest as a matter of policy.
