Municipal Bonds -- Supremes May Soon Change Tax Status for Better

Anyone who buys municipal bonds knows the tax advantages of buying municipals issued by or in the buyer's state of residence. By so doing, bond interest is not only free of federal taxes, but of state taxes too. The problem has always been that owning municipals from other states provides exemption only from federal taxes, not state taxes. The Supreme Court has agreed to take up a Kansas Court of Appeals case holding that one State taxing municipal income from another state is illegal. If the Supreme Court sides with Kansas' Appeals Court, things will really get interesting in the bond market, and all of it in favor of buyers of municipal bonds.

A Supreme Court ruling upholding the lower court's ruling will change the municipal bond market fundamentally and will force states to become competitive in setting rates. No longer will high tax states like New York and California be able to coerce its residents to buy only their bonds in order to receive state tax-free income. A ruling by the Supreme Court of this kind as early as next May, indeed, will blow the market wide open and bond buyers for the first time will have all 50 states from which to choose.

The current system, which amounts to economic protectionism, would at last be dismantled. States, on the bright side, would likely find that more and more people will buy tax-exempt bonds, opening up an opportunity to many who have never before bought in this market.