Exempt-interest dividends from mutual funds are an enticing option for high- net-worth investors looking to hedge against a federal income tax bill. Generally, when investors buy municipal bonds, the interest income or dividends derived from them remain exempt from federal income tax in the United States.

In some cases, however, the interest-dividend derived from municipal bonds may be subject to one or more forms of state taxes, depending on the particular state in which the investor is located. To qualify as exempt-interest dividends, the funds must be reported on Form 1099-DIV in box 12.

For some taxpayers, exempt-interest dividends may also be subject to the alternative minimum tax (AMT), notwithstanding the fact that they are exempt from federal and state tax. Because of the complex nature of mutual fund tax law, investors should consult with a tax advisor before investing in any municipal bond fund or related product.

The advantages of exempt-interest dividends from mutual funds can make them attractive to high- net-worth individuals looking to realize a significant tax savings. However, investors should always be aware of the potential for state taxes or alternative minimum taxes in regards to their investment income. As with any financial decision, investors should think carefully before committing their money to any type of tax-exempt investment.