Interest from a Treasury money market fund is generally exempt from state and local income taxes, but only the portion of the fund’s income that comes from direct U.S. government obligations qualifies. A fund with “Treasury” in its name typically holds Treasury bills, notes, and bonds, so nearly all of its dividends pass through free of state tax. Funds labeled “government” or “federal” are a different animal, because they mix in agency debt and repurchase agreements that don’t get the same treatment.
Why Treasury Interest Escapes State Tax
States can’t tax the federal government’s borrowing. Congress put that principle into statute at 31 U.S.C. § 3124, which exempts obligations of the United States from taxation by any state or local government.1Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation When a money market fund collects interest on Treasuries and passes it to shareholders as dividends, the income keeps its tax-exempt character. Section 3124(b) specifically addresses dividends and other income from evidences of ownership issued by the government, so the exemption survives the trip through the fund.
Treasury Funds vs. Government or Federal Funds
The word on the fund’s label carries real tax consequences. A Treasury money market fund invests exclusively in short-term U.S. Treasury securities. A government or federal money market fund invests in a broader mix that can include Treasuries, agency debt, and repurchase agreements. Your state tax benefit depends on which category the fund sits in.
Vanguard’s 2025 tax-year data shows the gap plainly. The Vanguard Treasury Money Market Fund reported 100% of its income from qualifying U.S. government obligations, so every dollar of dividends was potentially exempt at the state level. The Federal Money Market Fund came in at roughly 66.6%, and the Cash Reserves Federal Money Market Fund at about 69.6%.2Vanguard. US Government Obligations Income Information About a third of the federal fund’s income was fully taxable on state returns. If squeezing every dollar of state-tax benefit out of your cash matters, the Treasury-only label is the one to look for.
What Inside the Fund Actually Qualifies
The exemption covers direct obligations of the United States — instruments where the federal government itself is the borrower. Treasury bills, notes, and bonds are the clean examples, and income from them is shielded from state and local tax.3Vanguard. How Government Bonds Are Taxed
Repurchase agreements are the main reason a government fund’s qualifying percentage drops below 100%. In a repo, the fund lends cash and takes Treasuries as collateral, with the counterparty agreeing to buy them back at a slightly higher price. Even though Treasuries sit on the other side of the trade, the fund holds a short-term loan rather than owning the securities in the tax sense. Most states treat repo income as fully taxable lending income.
Agency securities land in a mixed zone. Federal Home Loan Bank obligations are exempt from state and local taxes under their authorizing statute.4Office of the Law Revision Counsel. 12 USC 1433 – Exemption From Taxation Farm Credit System obligations carry a similar statutory exemption.5Farm Credit Administration. Farm Credit Act of 1971, as Amended Fannie Mae and Freddie Mac securities generally do not qualify, and Ginnie Mae pass-throughs lack a state tax exemption in most states. A fund heavy in Fannie or Freddie debt will show a lower qualifying percentage as a result.
State Threshold Rules That Can Wipe Out the Exemption
Some states impose a minimum before you can claim any exemption. California, Connecticut, and New York require that at least 50% of a fund’s assets be invested in qualifying U.S. government obligations at the end of each quarter during the tax year.6Vanguard. US Government Obligations Income Information Miss the threshold in a single quarter and the entire distribution becomes taxable in those states, not just the non-qualifying share.
This is an all-or-nothing rule. A fund that hit 49% qualifying assets in one quarter would leave a New York investor owing state tax on 100% of the year’s dividends, even though nearly half the income actually came from Treasuries. Treasury-only funds generally clear the bar without trouble; government and federal funds can run close to the edge depending on how the manager allocates.
States With No Income Tax
If you live in a state that doesn’t tax individual income, the question is moot. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming do not tax personal income, and New Hampshire eliminated its tax on interest and dividends starting in 2025. In these states, Treasury interest reaches you untaxed no matter what kind of fund holds it, and there’s no tax-driven reason to prefer a Treasury fund over a government fund.
How to Find Your Fund’s Qualifying Percentage
Your Form 1099-DIV reports total ordinary dividends in Box 1a but doesn’t break out the portion that came from U.S. government obligations.7Internal Revenue Service. Form 1099-DIV Box 12 is for exempt-interest dividends from municipal bond funds, which is a separate exemption and not what you need here.
Fund companies publish a supplemental tax document each year showing the percentage of each fund’s income derived from U.S. government obligations. Fidelity includes it in a supplemental section of the 1099 tax statement for brokerage accounts, or on year-end statements for mutual fund accounts.8Fidelity. 2025 Percentage of Income From US Government Securities Vanguard publishes a standalone document covering all its funds.2Vanguard. US Government Obligations Income Information Other fund families do the same. These documents usually appear in February or March, sometimes a few weeks behind the 1099-DIV, and can generally be found on the fund company’s tax center page.
Claiming the Subtraction on Your State Return
The math is straightforward. Multiply the total ordinary dividends in Box 1a of your 1099-DIV by the qualifying percentage from the supplemental document.9Capital Group. State Tax Exclusion for US Government Income Worksheet On $5,000 in dividends from a fund reporting 100%, the exempt amount is $5,000. At 67%, it’s $3,350.
The subtraction happens only on your state return, on the line or schedule your state uses for adjustments to federal adjusted gross income. Your federal return still includes the full dividend as ordinary income; the state gives back the portion tied to U.S. obligations. A common mistake is trying to remove the amount on the federal return or double-counting the subtraction on the state return, either of which creates a mismatch that can draw follow-up. Keep the supplemental tax document with your 1099-DIV in case the state asks for substantiation.