Final answer:
The answer to the question is option C, as high-income taxpayers generally benefit greatly from the tax-exempt nature of zero-coupon municipal bonds, contrary to what the option suggests.
Step-by-step explanation:
Each of the following is a reason why zero-coupon bonds is the best way for high-income taxpayers to extract maximum value from tax-exempt state and local government bonds EXCEPT:
- A) Interest income is not subject to federal income tax.
- B) The investor can defer reporting interest income until maturity.
- C) High-income taxpayers may have limited benefit from tax-exempt interest.
- D) Zero-coupon bonds may result in a lower overall tax burden for high-income taxpayers.
The correct answer to this question is option C, 'High-income taxpayers may have limited benefit from tax-exempt interest,' because high-income taxpayers stand to benefit significantly from the tax-exempt nature of zero-coupon municipal bonds, and it's not accurate to suggest they have limited benefit.
Zero-coupon bonds are a type of bond that does not pay periodic interest payments. Instead, the investor buys the bond at a discount to its face value and receives the full face value at maturity. This structure can be especially advantageous for investors in higher income brackets when the bonds are tax-exempt, because the investor does not have to pay federal income tax on the accumulated interest until the bond matures, thus deferring the tax liability potentially until they are in a lower tax bracket. Additionally, since zero-coupon bonds do not pay interest until maturity, they may align well with planning for future expenses, such as retirement or educational costs, without having to manage yearly tax on interest.