Taxable Municipal Bond

Most municipal bonds are exempt from federal taxes. The theory goes that these local government projects create value for the community, so the federal government gives the bonds a market advantage by making them tax-free.

However, if the federal government determines that a particular bond issue does not create funds that will be used for helping the overall local community, it might deny tax-exempt status. Like, say, new rims for the mayor's car, or a luxury salon in City Hall that can only be used by members of the city council.

These situations lead to taxable municipal bonds: debt securities issued by local governments that don’t get the usual break from federal taxes.