California Municipal Bonds and Taxes: What Every Investor Should Know
If you live in California and invest in municipal bonds (“munis”), you’ve probably heard they can be “tax-free.” But in reality, the rules are more nuanced — especially when it comes to how California treats bonds issued by other states.
At Velin & Associates, Inc., we work with YouTubers, Shopify store owners, TikTokers, Amazon sellers, dentists, doctors, and high-net-worth individuals in Los Angeles who often ask: “Should I buy California municipal bonds or out-of-state bonds?” This article will walk you through the basics, using simple examples, so you can understand how federal and California state taxes apply.
What Are Municipal Bonds?
Municipal bonds are essentially loans you make to a state, city, or local government. In exchange, you receive interest payments over time, and your money is paid back when the bond matures.
People invest in municipal bonds because:
- They are generally considered lower risk than stocks.
- They provide predictable interest income.
- The interest often comes with tax advantages.
For professionals and small business owners with high tax bills, muni bonds can be a way to diversify investments while lowering taxable income.
Federal Taxes: Always Tax-Free on Interest
The good news is straightforward: all municipal bond interest is exempt from federal income tax.
- Buy a California bond? No federal tax.
- Buy a New York bond? Still no federal tax.
- Buy a District of Columbia bond? No federal tax.
This special rule is designed to make borrowing cheaper for governments — and it helps investors like you keep more of your earnings.
California State Taxes: Location Is Everything
Here’s the catch: California does not extend tax breaks to bonds issued by other states.
- California-issued municipal bonds → Interest is exempt from California state income tax.
- Out-of-state municipal bonds (including D.C.) → Interest is taxable on your California state return.
This means two investors with the same $10,000 of municipal bond interest could end up with very different after-tax income depending on where their bonds were issued.
Examples for Los Angeles Residents
Example 1: Local Bond (Los Angeles)
- You invest in a City of Los Angeles bond.
- Interest earned = $5,000.
- Federal tax: $0
- California tax: $0
- ✅ Result: You keep all $5,000.
Example 2: Out-of-State Bond (New York)
- You invest in a New York City bond.
- Interest earned = $5,000.
- Federal tax: $0
- California tax: ~$660 (assuming 13.2% top bracket).
- ❌ Result: You only keep about $4,340.
Example 3: District of Columbia Bond
- You invest in a D.C. bond.
- Interest earned = $5,000.
- Federal tax: $0
- California tax: ~$660.
- ❌ Result: Same as New York — taxable in California.
Quick Reference Chart
| Bond Issuer | Federal Tax | California State Tax | After-Tax Interest* |
| Los Angeles (CA) bond | ❌ None | ❌ None | $5,000 |
| New York City bond | ❌ None | ✅ Tax applies | $4,340 |
| District of Columbia bond | ❌ None | ✅ Tax applies | $4,340 |
(Assumes $5,000 interest and 13.2% CA top bracket)
Why This Matters for Creators, Dentists, and Small Businesses
High-income professionals — whether you’re a dentist with a growing practice, a YouTuber with brand deals, or a Shopify store owner with strong sales — often face steep California tax bills. Choosing California muni bonds over out-of-state bonds could save thousands each year in state taxes.
For example, if you hold $200,000 of out-of-state bonds paying 5% interest, that’s $10,000 of annual income. California would tax this at up to 13.2%, costing you $1,320. The same $200,000 in California bonds would cost you nothing in state tax.
Strategy Considerations
- Compare yields carefully: Sometimes out-of-state bonds pay higher interest to compensate for taxes. Compare after-tax returns, not just stated yields.
- Diversification vs. tax savings: While California bonds save on state taxes, diversifying into other states may lower risk exposure to California’s economy.
- Tax brackets matter: The higher your California income tax rate, the more valuable in-state bonds become.
- Pair with other deductions: Municipal bond strategies should be combined with business deductions, retirement contributions, and real estate planning for maximum effect.
Bottom Line
- Federal: All muni bond interest is tax-free.
- California State: Only California-issued bonds are tax-free; out-of-state muni interest is taxable.
- Action Step: Always compare after-tax returns and work with a CPA to structure investments for your overall tax strategy.
At Velin & Associates, Inc., we help Los Angeles professionals — from dentists and doctors to YouTubers, Shopify store owners, Amazon sellers, and TikTokers — navigate California’s tax rules and find smarter ways to invest and save.
Ready to see if municipal bonds fit your tax plan? Contact us today.
Velin & Associates, Inc
8159 Santa Monica Blvd STE 198/200 West Hollywood, CA 90046
323-902-1000
dmitriy@losangelescpa.org
Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.