Which type of bonds are exempt from state and local taxes?

Municipal bonds are specifically designed to be exempt from federal income taxes, and many states and local governments also exempt them from state and local taxes. This tax advantage makes municipal bonds particularly attractive to investors in higher tax brackets, as the after-tax yield can be significantly better than that of taxable bonds.

Treasury bonds, on the other hand, are exempt from state and local taxes, but they are still subject to federal income taxes. Corporate bonds and savings bonds do not enjoy the same tax benefits as municipal bonds, as interest earned from these is taxed at both the federal and state levels. Consequently, the correct answer highlights the specific tax advantages that municipal bonds provide, distinguishing them from other bond types.