Yes, agency bonds are taxable, but not uniformly. Interest from every agency bond is subject to federal income tax, no matter which issuer sold it to you. State and local taxation is the part that splits: bonds from the Federal Home Loan Banks, the Farm Credit Banks, and the Tennessee Valley Authority are exempt from state and local income tax, while bonds from Fannie Mae, Freddie Mac, and Ginnie Mae are fully taxable at every level. The dividing line is whether the statute that created the issuer specifically exempts its obligations from state tax.
Federal Tax Applies to Every Agency Bond
The interest you receive from any agency bond goes on your federal return as ordinary interest income. That is true for government-sponsored enterprises like Fannie Mae and Freddie Mac, for federal instrumentalities like the Federal Home Loan Banks, and for government-owned corporations like Ginnie Mae. You report it on Form 1040 the same way you would report interest from a corporate bond or a savings account.1Internal Revenue Service. Topic No. 403 – Interest Received
This is where agency bonds part company with municipal bonds. Municipal bond interest is generally excluded from federal income tax. Agency bond interest never is. If you own both, that gap matters when you compare after-tax yields.
Why State Tax Depends on the Issuer
Federal law exempts “stocks and obligations of the United States Government” from state and local taxation, with narrow carveouts for estate taxes and certain franchise taxes.2Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation That is why Treasury interest is always state-tax-free.
Agency bonds do not sit under that same umbrella automatically. Their treatment is set by the Internal Revenue Code and, more importantly, by the specific enabling statute Congress passed when it chartered each issuer. If that charter says the agency’s bonds are exempt from state and local tax as to interest, they are. If the charter only exempts the corporation itself, or says nothing at all about the bonds, then bondholders owe state tax on the interest.
Two agency bonds that look nearly identical on your broker’s screen can carry very different state tax bills for this reason. It is worth knowing which side of the line each of your holdings sits on before you file.
Agency Bonds That Are State-Tax-Exempt
A short list of issuers have charters that explicitly exempt their obligations from state and local tax. Interest from these bonds is federally taxable but state-free.
Federal Home Loan Banks
The Federal Home Loan Bank Act exempts all notes, debentures, bonds, and other obligations issued by any Federal Home Loan Bank “both as to principal and interest from all taxation” imposed by any state, county, municipality, or local authority. Estate, inheritance, and gift taxes are the only exceptions.3Office of the Law Revision Counsel. 12 US Code 1433 – Exemption From Taxation; Obligations Acceptable as Credit on Debt of Home Owner
Farm Credit Banks
The Farm Credit Act designates Farm Credit Bank obligations as instrumentalities of the United States and exempts their income from all federal, state, municipal, and local taxation other than federal income tax.4GovInfo. 12 USC 2023 – Tax Treatment of Farm Credit Bank Obligations Secondary-market buyers get the same state exemption as investors who bought at issue.5Congressional Research Service. Farm Credit System
Tennessee Valley Authority
TVA bonds are exempt from state and local taxation as to both principal and interest, with the usual estate, inheritance, and gift tax exceptions.6GovInfo. 16 USC 831n-4 – Tennessee Valley Authority Bonds TVA is a federally owned corporation rather than a government-sponsored enterprise, and Congress wrote the exemption into its enabling law.
Each of these statutes shares one feature: Congress said the obligations themselves are exempt as to interest. That phrase is what makes the difference.
Agency Bonds That Are Fully Taxable
The large housing issuers sit on the other side of the line. Their charters exempt the corporate entity from state tax but do not extend the exemption to interest paid to bondholders.
Fannie Mae
The Federal National Mortgage Association Charter Act exempts the corporation, its capital, reserves, surplus, and income from state and local taxation.7GovInfo. 12 USC 1723a – Federal National Mortgage Association Charter Act Read fast, that sounds like it should cover the bonds. It does not. The statute shields Fannie Mae as an institution from paying state tax on its own income. It never says the obligations Fannie Mae issues are exempt as to interest in the hands of investors. Compare it with the FHLB language, which does exempt the bonds themselves, and the gap is clear. State tax applies.
Freddie Mac
The Federal Home Loan Mortgage Corporation Act uses nearly identical wording: the corporation, its franchise, activities, capital, reserves, surplus, and income are exempt from state and local tax.8Freddie Mac. Federal Home Loan Mortgage Corporation Act Again the shield covers the entity, not the bondholder’s interest. The result matches Fannie Mae: you owe state and local tax on the coupon.
Ginnie Mae
Ginnie Mae is a government-owned corporation inside the Department of Housing and Urban Development. It does not issue bonds directly. It guarantees mortgage-backed securities issued by approved lenders, backed by the full faith and credit of the United States. Even with that federal backing, interest on Ginnie Mae mortgage-backed securities is generally taxable at the state and local level, because the cash reaching investors is a pass-through of underlying private mortgage payments rather than interest on a direct government obligation. Most states and brokerages treat it that way.
The 3.8% Net Investment Income Tax
Higher-income investors face a federal surtax on top of ordinary income tax. The net investment income tax adds 3.8% when your modified adjusted gross income crosses the statutory thresholds, and interest from agency bonds counts as net investment income.9Internal Revenue Service. Topic No. 559, Net Investment Income Tax
The MAGI thresholds are:
- $250,000 for married filing jointly
- $200,000 for single filers and heads of household
- $125,000 for married filing separately
These thresholds are set by statute and do not adjust for inflation, so more taxpayers cross them each year. If you are near one, your effective federal rate on agency bond interest is your marginal rate plus 3.8%. Municipal bond interest is excluded from both regular federal tax and the NIIT, which changes the comparison at higher incomes.9Internal Revenue Service. Topic No. 559, Net Investment Income Tax
Selling Before Maturity
Interest is not the only taxable event. Selling an agency bond before it matures produces a gain or loss measured against your adjusted cost basis, and the treatment depends on holding period and how you bought the bond.
Capital Gains and Losses
Sell for more than your adjusted basis and the profit is a capital gain. Hold longer than one year and it qualifies for long-term rates of 0%, 15%, or 20% depending on your income. Sell within a year and the gain is taxed as ordinary income. Losses work in reverse: they offset capital gains, and up to $3,000 of ordinary income per year.
Market Discount
If you buy an agency bond on the secondary market below face value, the discount may be treated as ordinary income rather than capital gain when you sell or redeem. A de minimis exception applies: if the discount is under 0.25% of face value for each full year remaining to maturity, the gain gets capital gains treatment instead. On a $1,000 face bond with 10 years to run, the threshold is $25. A $20 discount gets capital gains treatment. A $30 discount is ordinary income.
Premium Amortization
Pay more than face value and you can elect to amortize the premium over the bond’s remaining life. Each year the amortized amount reduces the taxable interest you report from that bond. The IRS requires the constant yield method. There is a catch. Once you elect amortization on taxable bonds, the election covers every taxable bond you own and every one you buy in the future, and it is effectively permanent unless the IRS grants permission to revoke. Your cost basis drops by the amortized amount each year, which affects any gain or loss on a later sale.10Office of the Law Revision Counsel. 26 US Code 171 – Amortizable Bond Premium
What Your 1099 Shows and What to Do at State Filing
Your broker reports agency bond interest on Form 1099-INT when the total is $10 or more for the year.11Internal Revenue Service. About Form 1099-INT, Interest Income Box 1 holds federally taxable interest, and every agency bond’s interest goes there because all of it is federally taxable. Box 3 is reserved for U.S. Savings Bond and Treasury interest and does not include agency bond interest.12Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
The 1099-INT has no dedicated box for interest that is federally taxable but state-exempt. Your brokerage typically issues a supplemental tax statement identifying the portion of Box 1 that came from FHLB, Farm Credit, TVA, or other state-exempt issuers. Use that supplemental detail on your state return to claim the exclusion. If you skip that step, the state has no way to know the interest qualifies.
Original Issue Discount
Some agency bonds are sold below face value, creating an original issue discount that accrues as taxable income each year even without a cash payment. When annual OID reaches $10, your broker reports it on Form 1099-OID instead of 1099-INT.13Internal Revenue Service. About Form 1099-OID, Original Issue Discount Federal tax is due on the accrued OID each year, so you pay tax on income you have not yet received in cash. State and local treatment of OID follows the same issuer rules as coupon interest: FHLB OID is state-exempt, Fannie Mae OID is not.
If You Hold Agency Bonds as a Nonresident Alien
Nonresident alien holders generally get favorable federal treatment. Portfolio interest on registered bonds issued after July 18, 1984 is excluded from U.S. income tax under the portfolio interest exemption, provided the interest is not connected to a U.S. trade or business.14Internal Revenue Service. Nonresident Aliens – Exclusions From Income Most agency bonds are registered securities and qualify. You may still owe tax in your country of residence, and you will need to file Form W-8BEN with your broker to claim the exemption and avoid backup withholding.