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Consider Taxation

For the operating-cash and stochastic-buffer tiers, the largest single after-tax move is choosing a vehicle whose interest is exempt from state income tax. Direct obligations of the United States — T-bills, T-notes, T-bonds, STRIPS — are state-tax-exempt under 31 U.S.C. § 3124. The exemption is invisible if you live in Texas or Florida and decisive if you live in California, New York, or any other high-state-tax jurisdiction.

Treasury-only vs. Government MMF Two money-market funds with similar nominal yield can have very different after-tax yields depending on what sits inside them:

Treasury-only MMFs ( SNSXX, VUSXX, FDLXX).: Hold direct US Treasury obligations almost exclusively. Interest passes through as state-tax-exempt federal-obligation income, reported on Form 1099-DIV with a supplemental percentage you use on your state return.
Government MMFs ( SPAXX, FZFXX, VMFXX).: Hold a mix of Treasuries, agency debt, and repurchase agreements. Repo income, despite being collateralized by Treasuries, is not state-tax-exempt. The state-exempt percentage on a typical government MMF commonly runs in the 20–55% range, year to year.
Prime (retail) MMFs ( SWVXX, SPRXX).: Hold commercial paper, negotiable CDs, and bank obligations alongside Treasuries and repo. They post the fattest nominal yield of the three and the thinnest after-tax yield for a high-bracket coastal resident, because essentially none of the income clears the state-obligation test — it is fully taxable federal and state. A prime fund yielding 20–30 basis points over a Treasury-only fund hands that entire edge, and then a chunk of principal-equivalent, straight to Sacramento or Albany; a California top-bracket holder keeps roughly 46 cents of a prime dollar against 59 cents of a Treasury dollar (the worked example below). Prime MMFs also carry the only real credit and liquidity-fee risk in this list — the 2008 Reserve Primary Fund “broke the buck” and froze redemptions precisely when its holders needed cash. The Rule 2a-7 amendments the SEC adopted in July 2023 abolished the redemption gates that made 2008 so ugly, and replaced them with fees: the board of a retail prime fund may impose a discretionary liquidity fee of up to 2% of the amount redeemed, and institutional prime and institutional tax-exempt funds face a mandatory fee once daily net redemptions exceed 5% of net assets. Use them for the fully-taxable corner of a portfolio, never for the cash layer of a high-tax-state household.

For California, Connecticut, and New York residents there is an additional cliff: state law permits the federal-obligation pass-through only if at least 50% of the fund’s assets sit in qualifying US obligations at the close of each quarter of the fund’s taxable year ( California R&TC § 17145 is the operative rule). SPAXX and similar government MMFs commonly drift below that 50% line because of their repo allocation, and when they do, none of the dividend is state-tax-exempt in those states for that year. A 40% state-exempt fund nationally pays zero state exemption in California. This is the kind of detail your tax preparer fills in for you silently while you wonder why the after-tax yield came out so low.

Worked example, California A California resident in the 37% federal bracket and the 13.3% state top rate (the 12.3% bracket plus the 1% BHST), well over the NIIT threshold ( $T_{}$

NIIT = 0.038 $), c o m p a r i n g a g o v e r n m e n t M M F t o a T r e a s u r y - o n l y M M F i n a y e a r w h e n t h e g o v e r n m e n t f u n d f a i l s t h e 50 % t e s t :$ Government MMF at 4.5% nominal, 0% state-exempt (failed cliff):

r_{}

after-tax = 0.045

\times [1 - 0.37 - 0.133 - 0.038] = 0.045 \times 0.459 \approx 2.07 %

Treasury-only MMF at 4.3% nominal, 100% state-exempt:

r_{}

after-tax = 0.043

\times [1 - 0.37 - 0.038] = 0.043 \times 0.592 \approx 2.55 %

The lower-yielding Treasury-only fund delivers roughly 48 basis points more after tax. Direct 4-week T-bills bought via the rolling ladder in section “Laddering and Rolling Strategies” land in the same place. At the operating-cash layer the dollar difference is small; at the stochastic-buffer layer with six- or seven-figure balances it is the difference between several thousand and several tens of thousands of dollars per year.

For high-bracket municipal-bond comparisons the full TEY-stacking framework is canonical at section “Municipal Bonds”. Municipal money market funds become competitive only above the federal-plus-state-exempt indifference point and rarely outyield Treasury-only funds after accounting for weekly rate resets and credit-spread volatility. For the emergency layer specifically, prefer Treasury direct.

If two choices have the same after-tax return, pick the one taxed less — lower adjusted gross income matters at the margin for IRMAA (section “IRMAA: The Stealth Tax with Cliffs”), NIIT thresholds, and the cliff stack in section “Cliff Choreography”.

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