What is a municipal bond?

A municipal bond, or muni, is a loan to a state, city, county, school district or other public body, which promises interest, usually every six months, and the return of the face value at maturity. Issuers use the money to build schools, roads, water systems and hospitals, and sometimes to cover day-to-day costs. The defining feature is tax treatment: interest on most munis is excluded from federal income tax, so they pay lower yields than taxable bonds of similar quality. Whether that trade works for a given saver depends on the tax bracket, which is why munis sit alongside Treasuries and CDs in the safe investments hub rather than above them.

How do general obligation and revenue bonds differ?

A general obligation bond is backed by the issuer's full faith and credit and taxing power; a revenue bond is repaid only from one income stream.

The MSRB lists toll roads and bridges, airports, electric and water utilities, colleges and hospitals among the projects behind revenue bonds. Most munis pay a fixed rate. They come in $1,000 multiples of face value and are typically sold in minimum denominations of $5,000, and an issue is often split into serial bonds that mature year by year, for up to 20 years, plus longer term bonds that come due on one date. A smaller group, variable rate demand obligations, resets its rate periodically and is bought mostly by institutions.

How is municipal bond interest taxed?

Interest on most state and local bonds is excluded from federal income tax, but the exclusion has conditions, and state taxes follow separate rules.

• Federal income tax. IRS Publication 550 says interest on a bond used to finance government operations generally is not taxable if a state, the District of Columbia, a US territory or one of their political subdivisions issued it. The interest still goes on Form 1040, line 2a, as an information item; reporting it does not make it taxable.
• Private activity bonds. A bond is generally private activity if more than 10% of the proceeds go to private business use and more than 10% of the payments are secured by or derived from that use. Its interest is taxable unless it is a qualified bond, and interest on specified private activity bonds issued after 2010 may be a preference item for the alternative minimum tax. Brokers report that amount in box 9 of Form 1099-INT, and the MSRB notes that such bonds yield more to compensate.
• Sales and discounts. Selling a muni can produce a capital gain or loss that must be reported, and market discount on a tax-exempt bond is not tax-exempt.
• State and local tax. The MSRB says the buyer generally must live in the issuing state for the interest to escape state and local income tax, with exceptions. In Department of Revenue of Kentucky v. Davis, decided May 19, 2008, the Supreme Court held that a state may exempt its own bonds while taxing those of other states. Treasury interest, by contrast, is exempt from state tax everywhere, as are T-bills taxable? explains.
• Other federal rules. The IRS lists tax-exempt interest among the kinds of income that are not net investment income, so the 3.8% surtax does not reach it. Publication 915 does count it, though, when testing whether Social Security benefits are taxable.

Some munis are fully taxable from the start: the MSRB notes that issuers sell taxable bonds when a financing does not meet the federal purpose or public use tests.

How do you calculate tax-equivalent yield?

Divide the muni's yield by one minus the tax rate a taxable bond's interest would face; the result is the taxable yield that leaves the same income.

Turned around, the same relationship gives the tax rate at which the two bonds pay the same:

The yield ratio in that break-even formula, muni yield over Treasury yield, is what the market quotes as the muni/Treasury ratio. At 10 years it rose from 65% at the end of 2025 to 78% on September 30, 2026, which cut the break-even rate from 35% to 22%: in nine months, munis went from paying off mainly for top-bracket households to paying off for anyone in the 24% bracket or above.

The right tax rate depends on what the muni is compared with. Against a Treasury, which states cannot tax, an in-state muni's state exemption adds nothing, so the federal rate alone fits. Against a CD or corporate bond, which states do tax, add the state rate. And because the net investment income tax of 3.8% on the smaller of net investment income and the amount by which modified AGI exceeds $200,000 (single) or $250,000 (married filing jointly) applies to Treasury interest but not to muni interest, a 35% taxpayer who owes it faces 38.8% on the Treasury, and the muni's tax-equivalent yield rises to 6.72%.

What risks do municipal bonds carry?

The main risks are default, early redemption by the issuer, falling prices when yields rise and the difficulty of selling quickly at a fair price.

• Credit risk. Defaults are rare. In Fitch's study of public finance ratings from 1999 to 2025, published June 4, 2026, 0.07% of investment-grade securities defaulted within five years and 0.18% within ten, against 6.01% and 6.89% for speculative-grade ones. Fitch's corporate study, which covers 1990 to 2025 and counts issuers rather than securities, puts the five-year rate for investment-grade companies at 0.64%. A GO pledge is still not a guarantee: Detroit announced it would not pay interest on its general obligation bonds due October 1, 2013, and Puerto Rico failed to pay in full the GO debt service due July 1, 2016. How agencies grade these issuers is covered under credit rating.
• Call risk. The MSRB says many munis are callable, though most cannot be called for a set period such as 10 years. Issuers call bonds when rates fall, to refinance more cheaply, so holders lose the income just when reinvesting pays less. Trade confirmations must show the yield to worst, the lowest yield allowing for calls; yield to maturity explains how the measures differ.
• Interest rate risk. Benchmark tax-exempt yields rose 61 to 105 basis points in September 2026 alone and 112 to 124 basis points over the third quarter, and on September 29 Bloomberg's BVAL curve hit all-time highs, in data from 2011, at maturities from 3 to 30 years. Prices of existing bonds fall when yields rise, by more for longer bond duration.
• Liquidity risk. Many buyers hold munis to maturity, so a given bond may trade rarely and quotes for it can differ. The MSRB says the risk is greater for lower-rated bonds, small issues, recent downgrades and infrequent issuers. In the September 2026 selloff, $3.8 billion of bonds was put out for bids on Bloomberg on September 29, second only to the more than $4 billion of March 19, 2020.

Where do you see municipal bonds?

You meet munis on EMMA, the MSRB's free disclosure website, on brokerage confirmations and tax forms, and inside funds that hold them.

• EMMA. Official statements, the muni market's equivalent of a prospectus, are posted there, along with continuing disclosures such as rating changes and missed payments, and historical and real-time trade prices. The SEC's bulletin warns that recent prices may be missing for bonds that seldom trade.
• Trade confirmations. Besides the yield to worst, a confirmation may disclose the broker's markup, which is how most brokers are paid on a bond trade.
• Tax forms. Interest appears in box 8 of Form 1099-INT, with any part subject to the alternative minimum tax repeated in box 9. Funds report exempt-interest dividends in box 12 of Form 1099-DIV and the AMT part in box 13.
• Funds and ETFs. Muni ETFs took in a net $55 billion in the first nine months of 2026, already above the $46 billion record for all of 2025, according to the MSRB, using Investment Company Institute data. Tax-exempt money market funds hold short municipal notes, as how money market funds work describes.
• New issues. Municipal issuers sold $467 billion of bonds in the first three quarters of 2026, on pace to pass $600 billion in a year for the first time.

How does a municipal bond differ from a Treasury or a corporate bond?

The issuer and the tax treatment differ most: munis are usually free of federal tax, Treasuries of state tax, and corporate bonds of neither.

A muni mutual fund or ETF is a different product: it pays exempt-interest dividends rather than interest, and unless the fund has a set end date, there is no maturity at which an investor gets face value back. How much extra yield a lower-rated muni pays over AAA debt is a credit spread question, and the tax-equivalent yield is the first step in reading it.

What mistakes do people make with municipal bonds?

Comparing raw yields undersells munis to high earners, while the label tax-free oversells them to people in low brackets.

• Skipping the conversion. At the September 30, 2026 yields above, the 10-year muni lost to the Treasury for anyone in the 22% bracket or below and won from the 24% bracket up, where 4.112% ÷ 0.76 = 5.41%.
• Assuming all muni income is tax-free. AMT interest, taxable munis, market discount, capital gains and other states' bonds can all bring a tax bill.
• Holding munis in a retirement account. IRA interest is not tax-exempt interest, so the lower yield is a cost with no matching benefit.
• Ignoring the call date. A bond bought above par can be called at the first call date, and its yield to worst, not its yield to maturity, is the realistic figure.
• Forgetting Social Security. Muni interest enters the benefits test even though it is not taxed itself.
• Treating a rating or a GO pledge as a promise. Detroit and Puerto Rico both carried GO debt that defaulted.

A muni carries more of some risks than a Treasury and less of others, a balance set out in types of investment risk. The taxable yields munis are measured against are charted daily on the Treasury yield curve page.