Question

Tammy, a resident of Virginia, is considering whether to purchase a North Carolina bond, face amount $100,000, that yields 4.6% before tax. She is in the 35% Federal marginal tax bracket and the 5% state marginal tax bracket. Tammy is aware that State of Virginia bonds of comparable risk are yielding 4.5%. Virginia bonds are exempt from Virginia tax, but the North Carolina bond interest is taxable in Virginia. Which of the two options will provide the greater after-tax return to Tammy? Tammy can deduct all state taxes paid on her Federal income tax return

Answer 1

It should purchase the Virginia Bonds.

Step-by-step explanation:

As the bonds are from another State they will be subject to taxation from both, the state and the Federal Government:

We comparethe after-tax yields:

North Carolina

0.046 x (1 - 0.40) = 0.0276 = 2.76% after-tax

Virginia

0.045 x (1 - 0.35) = 0,02925 = 2.925% after-tax

As the bond within the state provides a better yields Tammy should purchase there.