Municipal bonds are those issued by a state or local government to fund operations or specific projects. Not all are tax-free, though some are. When you do invest in non-taxable bonds, you still must report the interest earned on your Internal Revenue Service Form 1040. You also have to pay a federal capital-gains tax by filing Schedule D if you profited from the sale of the bonds. If you do not live in the state or municipality that issued the bonds, you might also need to pay state or local income tax on the bond interest.
Look for your IRS Form 1099-INT to arrive by mail. This form, which reports interest earned to the IRS, should arrive in January or February after the tax year end. Interest income is reported in Box 8 of the 1099-INT.Step 2
Enter the amount from Box 8 on Line 8b of IRS Form 1040. Line 8b is specifically for nontaxable interest and will not be added to your adjusted gross income.Step 3
Fill out Schedule D If you sold any municipal bonds. Even if you sold at a loss, you must complete Schedule D. Working through Schedule D allows you to discover whether you owe any tax on the sale. If you profited from the sale, report the amount on Line 13 of Form 1040. The gain will be taxed at a rate of 15 percent, as of 2012.Step 4
Report the interest income on your state or local return, as required, if you are a non-resident of the locality that issued the bonds.
- State and local tax laws vary. Check with your taxing authority to see whether you must report the tax-free bond interest on your state or local return.
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