Ohio/New Jersey taxation of Capital Gains Distributions from Ohio/New Jersey muni bond funds

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cas
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Ohio/New Jersey taxation of Capital Gains Distributions from Ohio/New Jersey muni bond funds

Post by cas » Sun Mar 17, 2019 10:31 am

It is commonly discussed that interest/dividends from state-specific muni bond funds (e.g Vanguard's Ohio Long-Term Tax-Exempt Fund or New Jersey Long-Term Tax-Exempt Fund) are exempt from taxation in that state (subject to requirements of specific state law).

My question involves state taxation of capital gains distributions (CGD) from state-specific muni bond funds, specifically in Ohio and/or New Jersey.

In many (most?) states, CGD from relevant-state muni bond funds are definitely taxable at the state level. However, several states - at least Ohio and New Jersey, maybe others - seem to exempt capital gains from sale of "public obligations" (for the relevant state) from state taxation.***

My question: Does this state-tax exemption on "capital gains on (relevant state) public obligations" extend to capital gains distributions (CGD) from the relevant specific-state municipal bond mutual fund? (e.g. Are CGD from the Vanguard Ohio Long-Term Tax Exempt Fund exempt from taxation on the Ohio state tax return? )

Or does the exemption apply only to sale of an actual relevant state municipal bond, held directly by the tax-payer?

On one hand, frequent-poster grabiner seems to say that CGD from NJ muni bond mutual funds *are* deductible from New Jersey income in this Boglehead's post (bold added by me). viewtopic.php?t=239630#p3748176
Capital gains on a NJ "qualified investment fund" (one which holds NJ tax-exempt investments) are exempt from NJ state tax; this should apply to distributions from the fund as well as capital gains on your own sales. You may need to prorate the gain according to the proportion of the fund which is exempt from NJ state tax. (This rule is specific to NJ; most states do tax capital gains on investments exempt from state tax.)


On the other hand, Turbotax is including the relevant CGD in state taxable income on the state tax form I'm currently working on (Ohio). (i.e. Turbotax either is implying that the Ohio tax exemption doesn't apply to capital gain distributions from Ohio muni-bond mutual funds or Turbotax is wrong. Wouldn't be the first time I've found a Turbotax problem with filling out the Ohio tax return, though.)

On the third hand, my google searches are turning up very close to Zero (just the grabiner post) on this whole topic. Given how much the tax exemption for *interest* from tax-exempt muni-bond funds is discussed, this seems odd, if the CGD exemption really does exist. Or maybe it isn't discussed because the exemption exists in the tax codes of only a small number of states.

Anyone have any insight?



***Ohio: (2018 instructions for IT 1040 Schedule A, Line 16, page 17)
You can also deduct any gains resulting from the sale or disposition of Ohio public obligations to the extent that the gain was included in your federal adjusted gross income.
Delving deeper into actual tax code adds no information ... pretty much just a repeat of the above sentence, as far as I can find.

New Jersey: (2018 instructions for NJ-1040, page 11 (pdf) or 9 (printed on page) )
Examples of Exempt (Nontaxable) Income
    Interest and capital gains from: (a) Obligations of the State of New Jersey or any of its political subdivisions; /quote]

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    grabiner
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    Re: Ohio/New Jersey taxation of Capital Gains Distributions from Ohio/New Jersey muni bond funds

    Post by grabiner » Sun Mar 17, 2019 9:32 pm

    For NJ, the reference is NJ Publication GIT- 5, Exempt Obligations:
    Qualified Investment Funds
    Distributions and gains from a New Jersey “qualified investment fund” are excludable from income to the
    extent that the distributions and gains come from the qualified exempt obligations held by the fund.
    ...
    A fund may hold up to 20% of its investments in obligations that are not tax-exempt. The portion of the
    fund’s distributions and gains that comes from those taxable investments must be reported as dividends
    and/or capital gains (as indicated on your Form 1099) on your New Jersey Income Tax return (Line 17 and/or
    Line 2, Schedule NJ-DOP, Form NJ‑1040 or Lines 17 and/or 19, Column A, Form NJ-1040NR).
    ...
    Mutual Funds
    Distributions received by shareholders of regulated investment companies, commonly referred to as “mutual
    funds,” are subject to New Jersey Income Tax. Taxable distributions include dividends and/or capital gains,
    unless the fund is a “qualified investment fund” for New Jersey purposes
    While I cannot give tax advice, this does appear to say that capital gain distributions in a qualified investment fund are exempt to the extent that the fund holds exempt securities. (If a fund is only 90% exempt, then 10% of its capital gain distributions would be taxable.)
    Wiki David Grabiner

    Topic Author
    cas
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    Re: Ohio/New Jersey taxation of Capital Gains Distributions from Ohio/New Jersey muni bond funds

    Post by cas » Mon Mar 18, 2019 9:59 am

    Thanks, David. I truly appreciate how generous you are with your time responding to all these types of questions here on Bogleheads.

    Your quote from the NJ documentation gave me some new ideas on terms to search for (with respect to Ohio law), which turned up some additional information in the Ohio Revised Code. Still no clear answer to my question, but at least I have more information on which to base a decision one way or the other.

    pescado
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    Re: Ohio/New Jersey taxation of Capital Gains Distributions from Ohio/New Jersey muni bond funds

    Post by pescado » Mon Apr 15, 2019 10:55 am

    cas:
    What did you end up deciding? I needed to make a similiar decision here in NJ.
    I had first asked my Vanguard advisor, after reading NJ GIT-5. He passed along an answer from an in-house expert colleague, who said "no" (to the question). I then emailed back the specific NJ GIT-5 passage that (I believe) shows the colleague's reasoning is wrong. I asked for a response in light of the new info I had provided.
    Six days later: still no response from the in-house colleague, via my advisor.
    Today, I discovered this forum. David's analysis echoes my own.
    Yes, TurboTax drops the ball on providing guidance on this specific matter. It should not be brain surgery for someone in the business. And TT must be highly profitable for its owner.

    Topic Author
    cas
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    Re: Ohio/New Jersey taxation of Capital Gains Distributions from Ohio/New Jersey muni bond funds

    Post by cas » Mon Apr 15, 2019 11:45 am

    I eventually decided to include the capital gains distributions from the Ohio-focused muni fund on my Ohio taxes.

    I went around and around, tracing through all the legal code defining all the relevant terms, but there was just never any phrasing that was anywhere near as specific as the New Jersey phrasing about what the tax treatment is supposed to be when you put "Ohio public obligations" inside the wrapper of a mutual fund (or "qualified investment fund"), and the fund kicks off capital gains distributions. (There *is* specific discussion about what the tax treatment is supposed to be when you put "Ohio public obligations" inside a mutual fund, and they kick off interest that is then passed on as dividends of the mutual fund. I thought it was suspicious that the opportunity wasn't taken at that point to say "hey ... we're talking about capital gains distributions, too, not just "interest".))

    I also thought it was suspicious that there was Zero discussion anywhere on the internet (that I could find) about subtracting capital gains distributions from Ohio-focused muni-bond funds from Ohio taxable income. Ditto for the footnotes on the annual memo from Vanguard on State Specific Tax Treatment of various distributions (i.e. no mention of Ohio, specifically, anywhere, even though there were footnotes for oddities in the tax codes of various other states, if I recall correctly.)

    I ultimately decided that, if the Ohio tax people audited me, there wasn't any strong evidence I could point to that would definitively support my case. (And I'm a NOT a personality who is comfortable taking a "better to beg forgiveness than ask permission in ambiguous cases" when it comes to taxes.)

    But, in the end, it was mostly that the tax code legalese stymied an ex-engineer who has a history of being able to handle dense technical specifications (in a variety of fields - not just engineering.) Frustrating.

    Sorry, that doesn't help much for the New Jersey case.

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