GETTING STARTED How to Adjust Your Withholding Track Down Your Tax Records Your Tax Form Checklist MORE... TAX TOOLS   From TaxCut by H&R Block Will you have to pay the alternative minimum tax in 2004?   Kiplinger Tools How much should I put in my flexible spending account? 2004 survey of state tax burdens Sponsored By: Recent Columns Fear of the AMT - Feb. 7, 2005 Track Your Basis - Feb. 4, 2005 Calculating Capital Gains Tax - Feb. 3, 2005 Capitalize on Property Settlement Costs - Feb. 2, 2005 Deducting Mortgage Interest - Feb. 1, 2005 Time for an IRA Distribution? - Dec. 15, 2004 MORE ...

TAX TIPS
Tax-Free Interest
by Kevin McCormally

Most investors in U.S. government securities -- such as Treasury notes and bonds and U.S. savings bonds -- know that the interest earned is tax-free on their state returns.

It's important to realize that some income paid by mutual funds gets this state-income-tax break, too. Ignore it and you'll pay too much to your state treasury.

Some money market mutual funds invest heavily in U.S. government obligations, so a substantial portion of the income they pay during the year is state tax-free. Some bond funds invest solely in U.S. government securities, so all of their income dividends are state tax-free.

You even can get state-income-tax-free income from stock mutual funds. Why? Because the portion of the fund's assets held in cash may be invested short-term in government obligations. The interest earned and passed on to shareholders may be state-tax-free.

Your funds should have advised you what portion of your income dividends may be state tax-free. That valuable information doesn't come on the 1099-DIV form that reports income, but in a separate document. Check your records or call the fund's toll-free number for details.