Fixed-income instruments are categorized by their issuer, credit risk profiles, and tax treatment under the Internal Revenue Code.
Issued by the U.S. Department of the Treasury and backed by the full faith and credit of the federal government, Treasuries carry negligible credit risk. The interest income is exempt from all state and local income taxes under federal law, though it remains subject to federal income tax.
Short-term debt with maturities ranging from 4 to 52 weeks. They are issued as zero-coupon securities at a discount to par and mature at face value. The minimum purchase is $100 via TreasuryDirect.gov or a brokerage account. They are highly liquid cash equivalents.
Fixed-rate nominal debt paying semi-annual coupons. Notes have maturities between 2 and 10 years; bonds are long-term instruments maturing in 20 or 30 years.
Treasury Inflation-Protected Securities (TIPS) TIPSs are designed to eliminate purchasing power risk. The principal value of the bond is adjusted semiannually based on changes in the consumer price index for all urban consumers (CPI-U), while the coupon rate remains fixed. Interest is paid semi-annually on the inflation-adjusted principal amount. At maturity, you receive the greater of the adjusted principal or the original par value.
However, the inflation adjustment to the principal is treated as taxable income in the year it occurs under the original issue discount (OID) rules of IRC §1272, “Current inclusion in income of original issue discount”, despite no cash distribution being made until maturity. This creates a “phantom income” tax liability. Consequently, TIPS are highly tax-inefficient in taxable accounts and should be held in tax-deferred accounts like IRAs or 401(k)s.
Series I Savings Bonds (I Bonds) I Bonds are non-marketable savings bonds designed to protect personal cash reserves from inflation. They earn interest based on a composite rate that combines a fixed rate (set at purchase) and a variable semiannual inflation rate linked to the CPI-U. Interest accrues monthly and compounds semiannually.
From a tax perspective, I Bonds are highly efficient: federal income tax can be deferred entirely until redemption or maturity (up to 30 years), and the interest is exempt from all state and local income taxes. If redeemed to pay for qualified higher education expenses, the interest may be completely exempt from federal income tax under the rules of the Education Savings Bond Program ( IRS Pub. 970).
However, the Treasury imposes structural purchase limits:
You must hold I Bonds for a minimum of 12 months. Redemptions within the first five years incur a penalty equal to the last three months of interest; after five years, no penalty applies.
Series EE Savings Bonds Series EE bonds are non-marketable savings bonds with a unique statutory floor: the U.S. Treasury guarantees that an EE bond will double in value exactly 20 years after purchase, regardless of the stated fixed interest rate. This step-up equates to a contractually locked-in compound annual growth rate (CAGR) of exactly 3.526%, completely free of state and local income taxes.
The stated fixed coupon rate (often 0.10% to 2.50%) is irrelevant. If the accrued interest from the stated rate fails to double the bond’s value by year 20, the Treasury makes a one-time upward adjustment to fulfill the guarantee. If the bond is redeemed prior to year 20, you receive only the posted coupon rate, turning the asset into a very low-yielding investment. Therefore, EE bonds must be treated as a strict 20-year commitment. They are limited to $10,000 per SSN per calendar year.
Municipal bonds (munis) are debt obligations issued by state and local governments, school districts, and public authorities. The defining characteristic of munis is that their interest income is completely exempt from federal income taxes. If you reside in the state of issuance, the interest is typically exempt from state and local income taxes as well.
Backed by the full faith, credit, and taxing power of the issuing municipality. GO bonds carry low credit risk.
Repaid solely from the cash flows generated by a specific public project (e.g., highway toll systems, water utilities, or airports). They carry higher yield premiums and default risk than GO bonds.
Issued by a public authority on behalf of a private entity (such as a private university, hospital system, or housing development). The private entity is solely responsible for debt service; if it defaults, the municipal issuer has no obligation to pay the bondholder.
Tax-Equivalent Yield (TEY) To compare a municipal bond’s return to a taxable corporate bond or Treasury, you must calculate its tax-equivalent yield. Because the Tax Cuts and Jobs Act (TCJA) capped the State and Local Tax (SALT) deduction under IRC §164(b)(6) at $10,000, state income taxes are not deductible against federal liabilities for high-income taxpayers. Therefore, federal, state, and Net Investment Income Tax (NIIT) rates stack additively. The full-stack TEY for an in-state municipal bond is:
Where:
For a high-income California resident in the top brackets, the total tax drag is (55.1%). An in-state California muni yielding 4.00% delivers a TEY of:
A taxable corporate bond or dividend-paying equity would need to yield 8.91% to deliver the same after-tax cash flow. Conversely, purchasing an out-of-state municipal bond exposes the interest to state income tax, stripping away the state tax shield and reducing the after-tax yield significantly. For high-bracket residents of high-tax states, in-state municipal bonds are a highly efficient fixed-income allocation.
Alternative Minimum Tax (AMT) and Private Activity Bonds While municipal interest is exempt from regular federal income tax, interest from Private Activity Bonds (PABs) — municipal debt issued to finance private enterprise projects such as sports arenas, airports, or industrial facilities — is treated as a tax preference item under IRC §57(a)(5), “Items of tax preference”. Under the Alternative Minimum Tax (AMT) system, PAB interest is taxed at rates up to 28%.
If you are projected to trigger the AMT (often due to substantial incentive stock option exercises), you must purchase “AMT-free” municipal bonds or funds that screen out PABs. However, if you are not subject to the AMT, avoid AMT-free funds: they typically yield 10 to 20 basis points less than standard municipal funds because of the screening constraint.
Corporate bonds are debt securities issued by public and private corporations. They are classified into two broad categories:
Rated BBB- (S&P) or Baa3 (Moody’s) and above. Issued by financially stable companies with low default probabilities. They offer modest yields and are highly liquid.
Rated below BBB-/Baa3. Issued by highly leveraged firms or distressed companies. They yield 3.5% to 8% over comparable Treasuries to compensate for high default rates (historically 8% to 24% during economic crises). High-yield bonds behave like equity proxies during macroeconomic downturns, losing value rapidly as credit spreads widen.
Corporate bond indentures contain protective covenants, which can be affirmative (e.g., maintaining minimum liquidity ratios) or negative (e.g., restricting the issuance of senior debt). You must distinguish between secured bonds (backed by specific collateral) and unsecured debentures (backed only by the cash-generating power of the firm).