Franklin High Yield Tax Free Income Fund Municipal Tax Information

Even tax-free income should be reported when you file your taxes.
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The Franklin High Yield Tax-Free Income Fund is a mutual fund that invests in municipal bonds, or those issued by cities and local governments. The fund's objective, as stated by its manager, Franklin Templeton Investments, is to provide investors a high rate of interest exempt from federal income tax. A secondary objective is to generate capital appreciation, or a rise in the share price. The company puts out relevant tax information on the fund every year.

Tax-Free Income

The amount of income the Franklin High Yield Tax-Free Income Fund distributes varies. By law, all mutual funds must distribute the income they receive from investments to shareholders. However, the amount this fund receives each year depends on the bonds it buys and sells and the rates it receives on these investments. For tax year 2012, the Franklin fund distributed about 46 cents a share in income, which was free of federal taxes.

State Tax Exemption

Municipal bond interest is usually only tax-free on the federal level. However, if you own bonds issued by your state, that income may be exempt from state income taxes, too. While the Franklin fund's investment goal isn't to distribute state tax-free income, a certain percentage of bonds it owns may qualify. The fund's manager issues a breakdown of its investment income by state at the end of the year to help you determine if any of your payments are exempt from taxes in your state. For example, for tax year 2012, nearly 18 percent of the fund's payouts were from California-issued municipal bonds, making them tax-free to shareholders in that state.

Capital Gains

Not all fund distributions represent tax-free income. If the Franklin fund sells a bond at a profit, it generates a capital gain. If the fund's net capital gains at the end of the year exceed its capital losses, it will make a capital gains distribution to shareholders. This distribution will be taxable to you as if you had generated the gain yourself. Long-term capital gains, or those held longer than one year, are taxed at a lower rate than short-term gains. However, any capital gains distribution from the fund will be taxable to you, even though the fund invests solely in tax-exempt bonds.

Tax Filing

Each year you own the Franklin fund you'll get a Form 1099-INT, showing how much income you received from it over the year. Your tax-free interest will be listed on line 8. If the fund pays out any taxable interest, it will appear on line 1. Information on capital gains distributions would be sent to you on Form 1099-DIV. Regardless of whether you receive tax-free, taxable or capital gains payouts, you'll have to report them on Form 1040 or 1040A when you file your income taxes.

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