What is the tax implication of accretion on original issue discount municipal bonds?

The tax implication of accretion on original issue discount (OID) municipal bonds is that it is not taxed. This means that while the bond increases in value as it approaches maturity (through the process of accretion), the gain from that increase is not subject to federal income tax. This tax treatment is a significant advantage of OID municipal bonds, making them an attractive investment option for many investors, particularly those in higher tax brackets.

The reason for this unique tax status stems from the nature of municipal bonds, which are often issued by governments to fund public projects and are designed to provide tax benefits to investors. Interest income from these bonds is typically exempt from federal income tax, and this exemption extends to the accretion of OID as well. As a result, investors can benefit from the growth of their investment without incurring tax liabilities during the life of the bond.

Understanding this aspect is crucial for investors who are evaluating the potential return on investment from municipal bonds, as the tax-free status of both the interest and the OID accretion can significantly enhance overall returns compared to taxable investments.