The 50% rule: which money funds keep their state tax exemption

Federal law forbids states to tax interest on obligations of the United States, and a mutual fund that earns such interest can pass the exemption to its shareholders. Most states let it through in proportion: if 60% of a fund’s income came from Treasuries, 60% of its dividend is exempt. California, Connecticut and New York add a condition. The fund must have held at least 50% of its total assets in qualifying obligations at the close of each quarter of its taxable year. A fund that meets the test passes through its exempt share as usual. A fund that misses it at even one quarter end passes through nothing, and the whole dividend for the year is taxed by those three states. The rule turns a gradual question into a cliff. In the 221 retail government and Treasury share classes behind this site, 92 held less than 50% in qualifying obligations at the June 30, 2026 or September 30, 2026 quarter end, $353.0 billion of assets in all, and 50 were within five points of the line on one of the two dates.

What counts, and what does not

The test counts obligations whose interest the state may not tax. Treasury bills, notes and bonds count. So does debt of a short list of agencies that Congress exempted from state tax: the Federal Home Loan Banks, whose statute shields their notes from state income tax, the Farm Credit Banks and the Tennessee Valley Authority. Fannie Mae and Freddie Mac securities do not count, though they are government-sponsored, because their charters do not carry the exemption. Repurchase agreements do not count either, and this is where most government funds lose ground. In a repo, the fund lends cash overnight to a bank or dealer and takes Treasuries or agency securities as collateral. The interest comes from the borrower, so it is not interest on a U.S. obligation, and the asset on the fund’s books is the loan, not the collateral. A government fund can therefore hold nothing but government paper in the sense of rule 2a-7 and still fall far below 50% for state tax purposes.

The holdings schedule in each Form N-MFP report is detailed enough to run the test: every security is listed with its issuer, its category and its value. This site classes each holding as Treasury, exempt agency, other agency, repo by type of collateral, municipal or other, and sums the first two as a share of total holdings at each quarter-end report.

Who failed in the data

The largest share classes below 50% at one of the two quarter ends were these (share of the fund’s money in U.S. government debt that the three states cannot tax). Several are among the biggest retail government funds in the country, and several carry the word Treasury or Government in their name.

The cost is concrete. A single Californian with $120,000 of taxable income and $50,000 in Schwab Treasury Obligations (SNOXX), which filed a yield of 3.60%, kept 2.40% after federal and California tax. The same money in Schwab U.S. Treasury (SNSXX), which filed 3.61% and held only Treasuries, kept 2.74%. The two funds sit side by side on the same platform and paid almost the same before tax.

Limits of the check on this site

The law looks at the close of each quarter of the fund’s own taxable year. Many funds use the calendar year; others end their fiscal year in another month, and their quarters close on other dates. This site has the monthly reports, so it reads the calendar quarter ends (June 30, 2026 and September 30, 2026 in the current data) as a proxy. A fund near the line can pass on its own dates and fail on the calendar ones, or the reverse. The share is also measured on holdings at market value as reported, while the law speaks of total assets, which include a little cash and receivables. For a fund at 70% or 30%, none of this matters. For a fund at 48% or 52%, the year-end letter from the fund company decides, and it usually states plainly whether the fund met the California, Connecticut and New York requirement.

Finally, the test is applied to every quarter of the year, and the current data covers only some of them. A fund that passed in June and September can still miss in December. The fund pages on this site show each quarter as it is filed; the after-tax figures assume that the quarters in the data are representative of the year.

What to do with the result

If your fund passed, the share of its dividend from U.S. obligations is subtracted on your state return: Schedule CA in California, the U.S. government interest line of Form IT-201 in New York, and the corresponding modification in Connecticut. The share to use is the one in the year-end letter, not the holdings estimate. If your fund failed, the whole dividend stays in your state income. Whether to change funds is your decision; the comparator on the home page ranks every share class for your state with the test applied, and each fund page shows the quarter-end figures.