As the brokerage 1099 forms for 2022 are coming out, here is a quick reminder for those in states with local income taxes. If you earned interest from a money market fund, a significant portion of this interest may have come from US Treasury bills and bonds, which are exempt from state and local income taxes. However, in order to claim this exemption, you’ll have to manually enter it on your tax return after digging up a few extra details.
Let’s take the default cash sweep option for Vanguard brokerage accounts, the Vanguard Federal Money Market Fund (VMFXX), which has an SEC yield of 4.29% as of 1/24/23. Vanguard has recently released the U.S. government obligations income information for 2022 [pdf] for all their funds, which states:
This tax update provides information to help you properly report your state and local tax liability on ordinary income distributions you received from your mutual fund investments in 2022. On the next page, you’ll find a list of Vanguard funds that earned a portion of their ordinary dividends from obligations of the U.S. government. Direct U.S. government obligations and certain U.S. government agency obligations are generally exempt from taxation in most states.*
To find the portion of Vanguard dividends that may be exempt from your state income tax, multiply the amount of “ordinary dividends” reported in Box 1a of your Form 1099-DIV by the percentage listed in the PDF. Note that on the IRS Form 1099-INT, there is a special Line 3 that includes “Interest on US Savings Bonds & Treasury obligations”. However, for the Vanguard funds, they report on 1099-DIV and not 1099-INT. My Vanguard 1099-INT was all zeros.
For the Vanguard Federal Money Market Fund, this percentage was 37.79% in 2022. Therefore, if you earned $1,000 in total interest from VMFXX in 2022, then $377.90 was exempt from state and local income taxes. If your marginal state income tax rate was 10%, that would be a ~$38 tax savings for every $1,000 in total interest.
Note that several other Vanguard funds have a significant percentage of dividends from US government obligations, including the popular Vanguard Target Retirement Income funds:
I don’t believe that TurboTax, H&R Block, and other tax software will do this automatically for you, as they won’t have the required information on their own. (I’m not sure if they ask about it in their interview process.) If you use an accountant, you should also double-check to make sure they use this information. Here is some information on how to enter this into TurboTax:
- When you are entering the 1099-DIV Box 1a, 1b, and 2a – click the “My form has info in other boxes (this is uncommon)” checkbox.
- Next, click on the option “A portion of these dividends is U.S. Government interest.”
- On the next screen enter the Government interest amount. This will be subtracted from your state return.
In the same way, municipal bond and money market funds will usually have their federally tax-exempt interest listed on the 1099-DIV, but they should also break down their interest down to the state-specific level elsewhere. This data was provided as part of my Vanguard 1099 forms. Your muni bond interest might be 100% exempt from federal income taxes, but most states also don’t tax their own municipal bond distributions. For example, dividends from the Vanguard Intermediate Tax-Exempt Fund was roughly 15% from New York, 10% from California, and 7% from Illinois.
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This is great info! Thanks Jonathan! Two questions:
There is Vanguard cash reserve federal money market and Vanguard federal money market. Do you know the difference?
Where did you get info on Intermediate tax exempt fund for specific state info?
VMRXX is formerly known as Vanguard Prime Money Market fund, a different money market fund than their default sweep.
https://investor.vanguard.com/investor-resources-education/news/changes-to-our-taxable-money-market-fund-lineup
Jonathan, please mention that a number of states, e.g., California, have a 50% in-state threshold to overcome to deduct anything. Notice the ** attached to some funds.
Very nice article.
A lot of us have large amounts in the target retirement funds and have been paying unnecessary state taxes
Does Fidelity have similar processes?
Yes, Fidelity publishes a “Percentage of Income From U.S. government securities” document, but it hasn’t been released for 2022 tax year yet. Expected early February.
I think you can find it here: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/taxes/GSE-Supplemental-Letter.pdf
Using the information from this post saved me $18 of state income tax in Virginia (marginal tax rate 5.75%)
Thank you very much for the great information!
Thanks, Jonathan, for this great info. I had quite a bit of interest from a credit union money market account in 2022. Do you have any insight on how to find the portion of income from government securities from a bank or credit union MMA?
“I don’t believe that TurboTax, H&R Block, and other tax software will do this automatically for you, as they won’t have the required information on their own. (I’m not sure if they ask about it in their interview process.)”
I’m pretty sure that H&R Block includes a question in the interview about percentages.
Thank you so much for publishing this. In H and R Block, you can input this on the “whole form” from your form 1099-DIV after importing it. Look for mini worksheet for Line 1a. First calculate the total percentage of box 1a from treasury obligations by adding up each piece and dividing it by my total dividend. For me it was 28.6%. This changes nothing on your fed but now show it clearly subtracted on my state 🙂
You’re amazing Jonathan. Thank you.
Do an update with fidelity and schwab funds when the information comes out please!
This never gets talked about. How many people are in target funds? You’re awesome.
California does not tax interest dividends from Mutual funds paid by a fund attributable to interest received by US obligations or California state or municipal obligations if at least 50% of the fund assets would be exempt from California tax when held by an individual.
Jonathan you indicated multiply the percentage (from Vanguard’s pdf) times box 1a on the 1099-DIV. Box 1a includes dividends from all my holdings. So wouldn’t I take the dividends I received on the Vanguard MM and multiply it by 37.79%?
I figured it out. I have 4 different brokerage accounts and they report dividends differently on the breakdown of each security.
Joanthan said:
If your marginal state income tax rate was 10%, that would be a ~$38 tax savings for every $1,000 in total interest.
So in IT 201 , where do you find the -$38.00 ? Is it on line 28, Interest income on U.S government bonds?
Thank you
Thanks