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 ($T_{\text{NIIT}}=0.038$), comparing a government MMF to a Treasury-only MMF in a year when the government fund fails the 50% test:

• Government MMF at 4.5% nominal, 0% state-exempt (failed cliff):

  $$r_{\text{after-tax}}=0.045\times \left[1-0.37-0.133-0.038\right]=0.045\times 0.459\approx 2.07\%$$

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

  $$r_{\text{after-tax}}=0.043\times \left[1-0.37-0.038\right]=0.043\times 0.592\approx 2.55\%$$

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”.