Interest earned from municipal bonds issued by states or political subdivisions outside Arizona is generally taxable for Arizona income tax purposes, even though it is excluded from federal gross income. Arizona requires this interest to be reported as an addition to income, unless a specific exemption under Arizona law applies.
Key Details
- Arizona municipal bond interest – Generally exempt from Arizona income tax.
- Non-Arizona municipal bond interest – Taxable by Arizona and reported as an addition to income.
- Taxpayers may reduce the addition by expenses incurred to purchase or carry the obligation that were not deductible for federal income tax purposes.
- If the addition is directly related to small business income reported on Form 140-SBI, it must be reported on Form 140-SBI instead of Form 140.
- Part-year residents include only interest from non-Arizona municipal bonds received while they were Arizona residents.
- Many taxpayers receive tax-exempt interest through:
- Municipal bond mutual funds
- Exchange-traded funds (ETFs)
- Brokerage accounts
- Only the portion of tax-exempt interest attributable to non-Arizona municipal obligations is added back for Arizona income tax purposes. Brokerage statements or Form 1099-DIV generally provide a state-by-state breakdown to determine the reportable amount.
Relevant Arizona Tax Forms and Publications
- Arizona Form 140 – Resident Personal Income Tax Return
- Arizona Form 140-SBI – Small Business Income Tax Return (when applicable)
Source:
Arizona Form 140 Instructions
Arizona Form 140-SBI Instructions
Disclaimer: Always verify details with the current year’s Federal and State Department of Revenue Forms and Instructions. Tax rules may change annually. For complex situations, consult a CPA or tax attorney.