Bonds issued by Puerto Rico, Guam and the Virgin Islands will continue to enjoy tax-exempt status, regardless of the upcoming Supreme Court decision on whether states may tax out-of-state muni bonds.
Last month the Supreme Court agreed to hear Kentucky v. Davis, a case focusing on whether states may tax residents’ interest income generated from out-of-state municipal bonds, while exempting their own. Currently, most states do not tax the interest on bonds issued locally, but do tax those from other states.
The court is expected to hear arguments on the case this fall and rule by the end of the court’s term next spring.
Historically, bonds of the three territories have been tax exempt for bondholders in every state due to federal laws designating the territories as “specialty states.” According to the Boston law firm of Mintz Levin Cohn Ferris Glovsky and Popeo PC, federal law prohibits states from taxing the debt of the three territories. Since federal law has higher standing than state law, the tax exemption would stand regardless of the outcome of the Kentucky case, according to Mintz Levin. So if the court rules that all bonds must receive equal treatment, bonds issued by the territories would remain tax exempt, even if states were to decide to tax the interest earned on all bonds.
The three U.S. territories issued a total of $6.2 billion of debt last year, mostly by Puerto Rico, according to the Bond Buyer.