The U.S. Supreme Court has agreed to hear the case of Commonwealth of Kentucky v. Davis in its next session. A recent issue of Businessweek contained an article, Shaky Times For Munis, discussing potential fallout from the decision in the case. If a ruling goes against (uphold the lower court ruling) the Commonwealth of Kentucky, single state municipal bond funds will likely become obsolete. The impact on the price of municipal bonds will depend on how each state decides to treat taxation of in state and out of state municipal bonds.
"States will have the unenviable choice of either making all bonds tax exempt or all taxable, said Jay Abrams," chief municipal credit analyst at FMSbonds, a muni bond brokerage. "States will either have to relinquish the income they derive from out-of-state bonds or begin taxing state residents on the interest they earn from in-state-issued bonds."
As noted in the article, high tax state muni bond holders could be especially hard hit. The article notes:
A New York City investor in the highest federal and state tax brackets earning 4% on an in-state bond or bond fund is earning the equivalent of 7% on a taxable bond.
If the lower court ruling is upheld, the states will need to decide if they tax in state municipal bonds like out of state bonds are currently taxed. In the above example of the New York investor, that 4% now tax free rate would not look too good if it ultimately becomes subject to state taxation.
Related posts and links from this blog:
- Kentucky v. Davis: A Review of the Supreme Court Briefs
- Municipal Bond Investors: No Smooth Sailing Ahead
- High Court on Trash Flow
Shaky Times For Munis
September 3, 2007