General Obligation Bonds

• In the municipal bond industry, general obligation bonds sit at the very top of the food chain. General obligation bonds are backed by the full faith and credit of the taxpayers of the municipality which issues the bonds. The credit rating on these bonds is based on demographic and economic data related to the tax base of the issuer.
  
  

Revenue Bonds

• Revenue bonds are a different breed. Revenue bonds are municipal bonds issued by governments for projects that generate income such as toll roads, hospitals and stadiums. The interest on these municipal bonds is paid from profits generated by the specific project. If there is no profit, investors do not get paid. Taxpayers do not guarantee revenue bonds.
  
  

Federal Tax Exemption

• The federal government does not tax the interest that investors receive from municipal bonds. This goes back to a Supreme Court decision in 1895 which states a level of government can tax only the interest of its own issues. Interest on municipal bonds is taxed at the state and local level, but not at the federal level.
  
  

Some State Tax Exemption

• If a municipal bond investor lives in the state where the bond is issued, he is not usually required to pay taxes on it. For instance, if he lives in Charleston and buys a state of South Carolina municipal bond, the interest would not be taxable on his federal or state tax forms. But if he bought a municipal bond issued in Georgia, the interest would be taxed by South Carolina.
  
  

High Income Investors

• Municipal bonds are best suited for people in high tax brackets who need to shield a portion of their wealth from exposure to taxes. The yields are lower on municipal bonds because the tax exemption plays a role in the total return an investor receives.