Taxable Muni Bonds- What are they, why are they?

May 07, 2023

Taxable municipal bonds, including Build America Bonds (BABs), are a type of municipal bond that are subject to federal income tax. Unlike traditional tax-exempt municipal bonds, the interest earned on taxable municipal bonds is taxable at the federal level, although it may still be exempt from state and local taxes.

One advantage of taxable municipal bonds is that they generally offer higher yields than tax-exempt municipal bonds, making them an attractive option for investors seeking higher returns or to utilize in a tax deferred account such as an IRA. This is because issuers of taxable municipal bonds may be able to offer higher interest rates than tax-exempt bonds due to the broader investor base for taxable bonds.

Build America Bonds (BABs) are a specific type of taxable municipal bond that were created as part of the American Recovery and Reinvestment Act of 2009. BABs are issued by state and local governments to finance infrastructure projects and other public purposes, and the interest paid on these bonds is taxable at the federal level.

One of the key features of BABs is that the federal government provides a subsidy to the issuer in the form of a tax credit or cash payment equal to a percentage of the interest paid on the bond. This subsidy allows issuers to offer lower interest rates on the bonds, making them more affordable for the issuer and potentially more attractive to investors.

Another advantage of BABs is that they are eligible for inclusion in certain fixed-income indices, which can increase their visibility and liquidity in the market. Additionally, BABs can be purchased by a wider range of investors than tax-exempt municipal bonds, including individual investors, corporations, and foreign investors.

However, like any investment, taxable municipal bonds and BABs come with risks. One risk is that the issuer may default on the bond, which could result in a loss of principal for the investor. Additionally, changes in interest rates can impact the value of the bond, as bond prices typically decline when interest rates rise. It is important for investors to carefully evaluate the creditworthiness of the issuer and the risks associated with any investment before making a decision.

In summary, taxable municipal bonds, including Build America Bonds, can be an attractive investment option for investors seeking higher yields than tax-exempt municipal bonds or to use in a tax deferred account. Investors in a lower tax bracket may benefit more on an after tax basis with a taxable vs. tax-free muni bond.  Investors should carefully evaluate the risks and rewards of any investment. Please call us to discuss your personal situation and whether taxable or tax free munis are an appropriate addition to your portfolio.