Final answer:
Walter must report the full $375 of interest from the Colorado municipal bond as taxable income on his California return because California taxes interest from municipal bonds issued by other states.
Step-by-step explanation:
The subject of this question revolves around the taxation of municipal bond interest for a resident of California who has earned interest from a bond issued by another state, in this case, Colorado. When preparing state tax returns, it is important to understand how different types of income are treated by state tax laws. In the case of California, the rules specify that interest from municipal bonds issued by states other than California should be included in the taxpayer's income and taxed accordingly.
Therefore, Walter should report the full $375 of interest he received from the Colorado municipal bond as taxable income on his California return. It is important to note that while interest from municipal bonds may be exempt from federal income tax, it is not necessarily exempt from state income tax unless it is from bonds issued by the taxpayer's state of residence.
In conclusion, the interest from the Colorado municipal bond that Walter received must be included in his California taxable income.