Interest on Treasury instruments is taxable at which level?

Interest on Treasury instruments, such as Treasury bills, notes, and bonds, is taxed at the federal level but exempt from state and local taxes. This unique tax treatment makes them particularly attractive to investors, as the interest income is not subject to state income tax, which can vary significantly among states.

The rationale behind this tax exemption is to encourage investment in government debt, thereby helping to finance government operations and expenditures. This federal tax liability means that while individuals and businesses must report the interest earned on their federal tax returns, they do not have to pay state or local taxes on this income. Understanding this distinction is essential for investors when considering the after-tax yield on different types of investments.