Mutual Funds 

How do mutual funds shareholders determine the amount of income that is from state tax exempt government bonds?

Interest from certain government and agency bonds may be passed through to mutual funds shareholders and thus qualify for state income tax exemption.

The exempt portion of the income distribution is equal to the percentage of mutual fund assets invested in qualifying securities.

In New York, California and Connecticut, a tax exemption for government income earned from mutual funds is only available to shareholders if at least 50% of the assets of the mutual funds at the end of each quarter of the fund’s fiscal year were invested in government securities that are considered tax exempt under state law.

What is the state income tax treatment for interest accrual on “stripped” government bonds?

The treatment of the interest accrual on “stripped” bonds (ETRs, STRIPs, CATs, TIGRs, FICOs) varies by state. Interest from “stripped” bonds does not necessarily have the same tax character for state income tax purposes, as would be the case if the bonds were held directly.

CA, NY, and NJ allow interest from “stripped securities” to be state income tax-exempt, but not all states follow that rule.

Interest accrual is taxable on a yearly basis at the federal level.