Which of the following types of interest income is not taxed as it is earned?

• A. Interest on corporate bonds
• B. Interest on savings accounts
• C. Interest on municipal bonds
• D. Interest on U.S. Treasury bills

Answer: (C)

Verified step by step guidance

1. Understand the concept of tax-exempt interest income: Certain types of interest income, such as interest earned on municipal bonds, are exempt from federal income tax. This is because municipal bonds are issued by state and local governments to fund public projects, and the tax exemption encourages investment in these bonds.
2. Review the taxation of corporate bonds: Interest earned on corporate bonds is taxable as it is earned because these bonds are issued by private companies, and the income generated is subject to federal and state taxes.
3. Examine the taxation of savings accounts: Interest earned on savings accounts is also taxable as it is earned. This type of interest income is considered ordinary income and must be reported on your tax return.
4. Analyze the taxation of U.S. Treasury bills: Interest earned on U.S. Treasury bills is subject to federal income tax but is exempt from state and local taxes. It is still taxed as it is earned at the federal level.
5. Conclude that municipal bonds are unique in this list because their interest income is not taxed at the federal level, making them the correct answer to the question.