Oregon Tax Consultants Practice Exam

How is interest income from US Treasury Bills, Notes, and Bonds treated on state returns?

1. It is taxed by state and local governments

2. It is exempt from state and local taxes

3. It is included in state taxable income

4. It is subject to the same rates as federal taxes

The correct answer is: It is exempt from state and local taxes

Interest income from U.S. Treasury Bills, Notes, and Bonds is exempt from state and local taxes. This treatment stems from a longstanding principle that provides federal government securities with a unique status designed to encourage investment in national debt. As a result, taxpayers do not have to include the interest earned from such Treasury securities when calculating their state or local taxable income. This exemption aligns with the policies at the federal level, where the federal government seeks to promote the use of its own debt instruments. States generally follow this exemption to avoid penalizing residents for investing in government securities. Thus, individuals can benefit from this interest income without the additional state tax burden, making it an attractive investment choice. In contrast, other types of interest income—such as that earned from corporate bonds or savings accounts—are typically subject to state and local taxes. This distinction further underscores the favorable tax treatment afforded to U.S. Treasury obligations compared to other income sources.