Is interest on state and local bonds included in gross income?

Interest earned on state and local government bonds is generally exempt from federal income tax, which is why the correct answer is that it is not included in gross income. This tax exemption is a key feature of municipal bonds, which is why many investors seek them out for their tax benefits.

The intent behind this exemption is to encourage investment in public projects and infrastructure by making these bonds more attractive to potential investors. Most state and local bonds, often referred to as municipal bonds, offer interest that is free from federal income taxes, and in some cases, even from state taxes, depending on the investor's residency.

While there may be rare exceptions where specific state bonds could be taxable under certain conditions, the general rule remains that the interest is not included in gross income for tax purposes. This makes investing in state and local bonds a favorable option for individuals looking to minimize their taxable income.