Why are US Treasury Bills exempt from state income tax?

US Treasury Bills are exempt from all state and local income taxes under 31 U.S.C. Section 3124. For residents of high-tax states such as California (13.3%) or New York (10.9%), a 4.80% Treasury Bill delivers a Tax-Equivalent Yield exceeding 5.60% compared to a fully taxable High-Yield Savings Account (HYSA).

How is Tax-Equivalent Yield (TEY) calculated for Treasury Bills?

Tax-Equivalent Yield equals the nominal Treasury yield multiplied by (1 - Federal Rate), divided by (1 - Combined Federal and State Rate). In high-tax states like California and New York, TEY increases nominal returns by 60 to 120 basis points.

Does the 3.8% Net Investment Income Tax (NIIT) apply to Treasury interest?

Yes. Treasury Bill interest is subject to federal income tax and the 3.8% NIIT for high earners exceeding statutory MAGI thresholds ($200k single / $250k married filing jointly). However, state income tax remains strictly 0%.

Fixed Income Arbitrage

Treasury Bill Yield vs HYSA Tax-Equivalent Yield Calculator

Calculate after-tax interest and Tax-Equivalent Yield (TEY) between state-tax-exempt US Treasury Bills and taxable HYSAs.

Yield & Tax Parameters

Cash Principal Investment ($)

US T-Bill Yield (%)

HYSA / CD Yield (%)

State of Residence

Federal Tax Bracket (%)

Apply 3.8% Net Investment Income Tax (NIIT)

Tax-Equivalent Yield Output

Tax-Equivalent Yield (TEY)

5.88%

Nominal HYSA rate needed to match T-Bill after taxes

Net After-Tax Treasury Income $7,344

Net After-Tax HYSA Income $5,389

Annual State Tax Saved $1,596

Net Annual T-Bill Advantage +$1,955

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State Tax Impact on 4.80% US Treasury vs HYSA Tax-Equivalent Yield

Comparison across statutory state tax jurisdictions assuming a 35.0% federal marginal bracket plus 3.8% NIIT (38.8% total federal rate). State tax exemption authorized by 31 U.S.C. Section 3124.

State Jurisdiction	Top State Rate	Combined HYSA Tax	4.80% T-Bill Net Yield	Tax-Equivalent HYSA Yield
California	13.30%	52.10%	2.94%	5.88% TEY
New York	10.90%	49.70%	2.94%	5.64% TEY
New Jersey	10.75%	49.55%	2.94%	5.62% TEY
Massachusetts	9.00%	47.80%	2.94%	5.46% TEY
Texas / Florida / Washington	0.00%	38.80%	2.94%	4.80% (Parity)

31 U.S.C. Section 3124 Statutory Exemption Mechanics

Title 31, United States Code, Section 3124 explicitly prohibits states and municipal jurisdictions from imposing property, income, or franchise taxes on obligations of the United States Government.

For high-net-worth operators, family offices, and corporate treasuries holding significant cash allocations, buying short-duration Treasury Bills directly eliminates state tax leakage, locking in a substantial risk-free premium over commercial bank cash equivalents.

Frequently Asked Questions

Are Treasury Bills exempt from federal income taxes?

No. Treasury Bills are 100% subject to federal income taxes and the 3.8% Net Investment Income Tax (NIIT). They are ONLY exempt from state and local municipal income taxes.

How does maturity affect the state tax exemption?

All direct Treasury obligations (4-week, 8-week, 13-week, 26-week, and 52-week T-Bills, as well as Treasury Notes and Bonds) enjoy identical statutory state tax exemption regardless of duration.

Do Treasury Money Market Funds (MMFs) also qualify?

Yes, provided the fund meets state statutory requirements (in California, New York, and Connecticut, funds must hold at least 50% direct US government obligations at each quarter-end to pass through the state tax exemption).

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