State Tax on Treasury Interest Explained - The 31 USC 3124 Exemption
The federal statute
From 31 U.S.C. §3124(a): "Stocks and obligations of the United States Government are exempt from taxation by a State or political subdivision of a State."
This is federal law. States cannot tax the interest. They cannot tax the principal-adjustment income on TIPS. They cannot tax the accrued interest on I-Bonds when redeemed (the federal tax applies; state does not).
The exemption was enacted in 1862 (in earlier form) to support Treasury borrowing during the Civil War, and has been continuously in force since. State legislatures occasionally probe the boundaries, but the Supreme Court has consistently upheld the federal supremacy of this provision.
What it covers
- T-bills (4-52 week) - discount accretion exempt
- T-notes (2, 3, 5, 7, 10 year) - coupon interest exempt
- T-bonds (20, 30 year) - coupon interest exempt
- TIPS (5, 10, 30 year) - both coupon AND inflation-adjustment income exempt
- I-Bonds (Series I Savings Bonds) - accrued interest exempt at redemption
- EE Bonds (Series EE Savings Bonds) - same
- FRNs (Treasury Floating Rate Notes) - reference rate + spread, all exempt
- STRIPS (zero-coupon Treasury STRIPS) - phantom income accretion exempt
What it does NOT cover
- Agency debt - Fannie Mae, Freddie Mac, Federal Home Loan Bank, Ginnie Mae - these are NOT direct Treasury obligations. Most are state-taxable. (Some states exempt some agency debt; check state-by-state.)
- Treasury ETFs - mostly exempt but not 100%. SGOV, BIL, USFR pass through Treasury exemption on the Treasury-direct portion (typically 90-100%). Verify Box 8 of your 1099-DIV/INT for the exempt percentage.
- Treasury mutual funds - same partial-exemption treatment as ETFs.
- Capital gains on Treasury sales - if you sell a Treasury before maturity at a price above your cost basis, the capital gain IS state-taxable. Only the interest is exempt.
- Repurchase agreements (repo) using Treasury collateral - the interest is generally state-taxable (you're earning repo rate, not Treasury yield).
State-by-state value of the exemption
| State | Top income tax rate | Exemption value on $250K @ 4.15% |
|---|---|---|
| California | 13.3% | ~$1,381/yr |
| New York (state) | 10.9% | ~$1,131/yr |
| New York City (+local) | +3.876% | ~$402/yr additional |
| Oregon | 9.9% | ~$1,028/yr |
| Hawaii | 11.0% | ~$1,142/yr |
| Minnesota | 9.85% | ~$1,022/yr |
| New Jersey | 10.75% | ~$1,116/yr |
| Connecticut | 6.99% | ~$726/yr |
| DC | 10.75% | ~$1,116/yr |
| Massachusetts | 9.0% | ~$934/yr (5% on most, 9% above $1M) |
| Texas, FL, NV, TN, WA, WY, SD, AK, NH, NV | 0% | $0 - no exemption value |
For a CA top-bracket retiree with $250K parked in Treasuries vs CDs at the same headline yield, the exemption is worth roughly $1,400/year - about 56 bps of after-tax yield differential. Over a 5-year hold: ~$7,000 of tax savings.
Practical application
Step 1: Compute the break-even CD yield
Formula: CD break-even yield = Treasury yield / (1 - State tax rate)
Example: 13-week T-bill at 4.25%, CA top bracket at 10.3% state:
Break-even CD yield = 4.25% / (1 - 0.103) = 4.74%
Any CD yielding below 4.74% loses to a 4.25% T-bill on after-tax basis for this CA resident.
Step 2: Check your state-tax forms
Your federal 1099-INT will show Treasury interest in Box 3 (separate from regular interest in Box 1). Most state tax software (TurboTax, H&R Block, FreeTaxUSA) automatically picks up the federal-vs-state distinction and excludes Box 3 from state taxable income. Verify on your state return that this happened - some manual entry is occasionally required.
Step 3: Don't double-tax in IRA wrappers
Inside a traditional IRA, 401(k), or other tax-deferred account, the state-tax exemption is irrelevant - the entire wrapper is already deferred. Buying Treasuries inside an IRA gets you no state-tax benefit (because there's no state tax to avoid). Use the exemption in taxable brokerage accounts where it actually delivers value.
Why people miss this exemption
- Headline-yield comparison. Most people look at "4.50% CD" vs "4.15% T-bill" and pick the CD without computing after-tax.
- Bank/broker advisors don't emphasize it. A CD recommendation is simpler to explain and execute; the tax math is implicit.
- State tax software handles it silently. The exemption appears as a state tax savings line item, not as an explicit yield comparison.
- Brokerage 1099 formatting. Some brokerage 1099s require manual classification of Treasury interest by the taxpayer.
The MYGA angle
MYGAs don't get the state-tax exemption on accrued gains (they're insurance contracts, not Treasury direct obligations). What MYGAs offer instead is full federal AND state tax DEFERRAL during accumulation. At withdrawal, the gain is taxed federally and at the state level as ordinary income.
The math:
- Treasury: Annual federal tax, no state tax. Net annual yield = pre-tax × (1 - fed)
- MYGA: Deferred federal AND state tax. Compounds gross. At withdrawal, taxed federal + state.
For a CA top-bracket retiree on $250K over 5 years: Treasury at 4.10% delivers ~$32K after-tax. MYGA at 5.50% delivers ~$40K after-tax. The MYGA's 140-bp yield premium and tax deferral overwhelm the Treasury's state-tax exemption advantage even for the highest-tax state.
FAQ
Does 31 USC 3124 apply to all U.S. states?
Yes. It's federal supremacy. Every state, every locality. Some states have additional exemptions for state-specific bonds; none can tax federal Treasury interest.
What about Puerto Rico, Guam, US Virgin Islands?
Treasury interest is also exempt under their respective tax codes (and these are not full 'states' for the supremacy clause). Verify locally for residency-specific rules.
Does the exemption apply to Treasury mutual funds?
Partially. The fund must hold at least 50% Treasury securities to qualify (per most state rules). The exempt portion is the percentage of the fund's income that came from direct Treasury holdings. Box 8 of the fund's 1099 will list this percentage.
If I sell a Treasury before maturity at a capital gain, is the gain exempt?
No. Only the interest income is exempt. Capital gains on Treasury sales are state-taxable in the same way as gains on any other security. Most retail Treasury investors hold to maturity, so this rarely matters.
Can my state make me 'add back' the Treasury interest?
No. The federal statute is unambiguous. States can require you to list Treasury interest separately on your state return for verification, but they cannot tax it.
Are Treasury STRIPS exempt the same way?
Yes. Treasury STRIPS' phantom-income accretion is exempt under 31 USC 3124 just like coupon interest. Hold STRIPS in IRAs to avoid the phantom-income tax friction federally, but state-level it's already exempt either way.
What about Treasury Inflation-Protected Securities (TIPS)?
Both the real-rate coupon AND the inflation-adjustment income are exempt from state and local tax. This is one of the underappreciated advantages of TIPS for high-tax-state residents.
Are agency bonds (Fannie/Freddie) exempt?
Generally no, with some state-specific exceptions. Fannie Mae, Freddie Mac, FHLB, and Ginnie Mae are not direct Treasury obligations and are typically state-taxable. A few states exempt some agencies; check your specific state.
Related reading
- T-bills vs CDs (state-tax decisive)
- T-bills vs HYSA after-tax math
- T-bills explained
- Treasury laddering
- 5-year Treasury vs 5-year MYGA
Use the state-tax exemption where it pays. Use MYGA deferral where it pays more.
Hans Goldstein, independent licensed insurance producer.
The state-tax exemption on Treasuries is real and matters in CA/NY/NJ/OR. For 3-10 year retirement money in any state, MYGAs from A-rated carriers pay 100-140 basis points more locked, with full federal AND state tax deferral - usually beating the Treasury's state-exemption advantage on cumulative after-tax dollars.
Drop your info and within 24 hours you'll get a written side-by-side: the Treasury option vs. the top 3 MYGAs from A-rated carriers at the same term, end-of-term math at your actual dollar amount, and after-tax yield computed at your state bracket. No pitch, no follow-up calls unless you ask.
Hans Goldstein · 213-414-2808 · NPN 20602398, independent licensed insurance producer appointed with multiple A-rated carriers
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Disclosure
This review reflects publicly available Treasury auction results, TreasuryDirect documentation, and approximate market yields as of the date stated above. Treasury yields change daily; current yields differ from prior auctions and may differ from those shown here. This article is general information for educational purposes; it is not a personalized recommendation, solicitation, or offer of any specific security or insurance product. U.S. Treasury securities are backed by the full faith and credit of the United States Government. MYGA references compare Treasury yields against approximate rates from A-rated insurance carriers as of the date stated; carrier rates change monthly. State guaranty fund coverage on annuities is provided by the state insurance department and varies by state (typically $250,000-$300,000 per owner per carrier). Hans Goldstein is an independent licensed insurance producer (NPN 20602398) appointed with multiple A-rated annuity carriers; he is NOT a registered investment advisor, broker-dealer, or registered representative, and is not paid by the U.S. Treasury, TreasuryDirect, or any brokerage for this review. No compensation has been received from any third party in connection with this content. Always read the actual offering documents and consult a licensed advisor before purchasing any security or annuity. Tax discussion of 31 U.S.C. §3124 and Internal Revenue Code provisions reflects law as of 2026 and is subject to change.