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Taxes and Tax-Free Bonds
Local and state governments borrow money by selling bonds. Commonly called municipal bonds, these securities frequently pay interest that is exempt from federal, state and local income taxes. Municipal bonds may be zero-coupon bonds. You receive a 1099-INT form each year stating the amount of bond interest you've earned. You must report this interest as income on your tax return and attach the 1099-INT. However, since the interest is tax-free, you then get to deduct it back out of your taxable income.
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