When is interest on a state or local government obligation generally not taxable?

Interest on state or local government obligations is generally not taxable when it matches the terms of a written agreement because this typically refers to the specifications defined in the bond agreement or related legal documents. Municipal bonds, which are issued by state and local governments, provide tax-exempt interest to the bondholders. This exemption is part of the incentive for investors, as it helps lower borrowing costs for state and local governments.

The relationship between the terms of the agreement and tax exemption is significant because it ensures that funds designated for specific purposes, such as public projects or infrastructure, are utilized in accordance with expectations set forth during the bond issuance. If the bond meets certain requirements outlined in the IRS code, such as being used for public interest projects or having particular qualifications, the interest earned generally remains exempt from federal income tax.

This context supports why matching the terms of a written agreement is critical for tax exemption, as it aligns with compliance and regulatory standards set for municipal financing.