How does the interest paid on a general obligation municipal bond typically differ from the interest paid on a corporate bond of comparable maturity for a resident investor?
- AThe corporate interest is generally exempt from federal income tax, while the municipal interest is fully taxable at the federal level.
- BBoth instruments pay interest that is exempt from federal income tax because each is a debt security.
- CThe municipal interest is generally exempt from federal income tax, while the corporate interest is fully taxable at the federal level. Correct
- DBoth instruments pay interest that is fully taxable at the federal level regardless of the issuer.
Why A is wrong: This reverses the true tax treatment, which is tempting for a candidate who confuses the two issuers, but it is wrong because municipals, not corporates, carry the federal exemption.
Why B is wrong: A candidate may assume all bond interest shares one tax status, yet corporate interest is federally taxable, so treating both as exempt is incorrect.
Why C is correct: General obligation municipal bonds pay interest that is normally free of federal income tax, whereas corporate bond interest is fully taxable federally, which is the core distinction candidates must grasp.
Why D is wrong: This looks safe because most investment income is taxed, but it ignores the federal exemption that municipal bond interest ordinarily receives.