Under federal law, an investor may or may not have to pay federal income taxes on debt interest. Earnings on corporate bonds and securities from the U.S. Treasury and other federal entities are subject to income taxes. Interest received from certain municipal debt, however, may be exempt from federal taxes.
Municipal bond interest may be exempt from federal income taxes if the bonds are used for governmental purposes such as building a state or local government building. In addition to the federal exemption, state law may exempt interest from municipal bonds from corresponding state and local taxes.