What aspect of Treasury instruments is different from municipal instruments regarding tax?

Municipal instruments are exempt from federal taxes, which makes them particularly attractive to investors in higher tax brackets. This tax exemption is designed to encourage investment in public projects and services at the state and local levels, such as schools and infrastructure. Because they are exempt from federal income taxes, the interest earned on municipal bonds is not subject to federal taxation, which can enhance the effective yield for investors.

In contrast, Treasury instruments, which include Treasury bills, notes, and bonds, are subject to federal income taxes. However, the interest from Treasury securities is exempt from state and local taxes. Therefore, while municipal bonds provide an advantage regarding federal tax exempt status, Treasury securities do not offer such federal tax advantages, highlighting the key difference between the two types of instruments. This understanding is vital for investors when making decisions about tax implications related to different types of bonds.