Updated for 2026. Tax time is here again, and if you earned interest from a money market fund, a significant portion of this interest may have come from “US Government Obligations” like Treasury bills and bonds, which are generally exempt from state and local income taxes. However, in order to claim this exemption, you’ll likely have to manually enter it on your tax return after digging up a few extra details.
(Note: California, Connecticut, and New York exempt dividend income only when the mutual fund has met certain minimum investments in U.S. government securities. They require that 50% of a mutual fund’s assets at each quarter-end within the tax year consist of U.S. government obligations.)
Vanguard has recently released the U.S. government obligations income information for Tax Year 2025 [pdf] for all their funds, which states:
This tax update provides information to help clients properly report state and local tax liability on ordinary income distributions received from mutual fund investments in 2025.
On the next page, you’ll find a list of Vanguard funds that earned a portion of their ordinary dividends from
obligations of the U.S. government. Direct U.S. government obligations and certain U.S. government agency
obligations are generally exempt from taxation in most states.1
To find the portion of Vanguard dividends that may be exempt from your state income tax, multiply the amount of “ordinary dividends” reported in Box 1a of your Form 1099-DIV by the percentage listed in the PDF. Note that on the IRS Form 1099-INT, there is a special Line 3 that includes “Interest on US Savings Bonds & Treasury obligations”. However, for the Vanguard funds, they report on 1099-DIV and not 1099-INT. My Vanguard 1099-INT was all zeros.
For the default cash sweep Vanguard Federal Money Market Fund (VMFXX), this percentage was 66.61% in 2025. (For reference, it was 59.87% in 2024 and 49.37% in 2023.) Therefore, if you earned $1,000 in total interest from VMFXX in 2025, then $666.10 could possibly be exempt from state and local income taxes. If your marginal state income tax rate was 10% that would be a ~$67 tax savings for every $1,000 in total interest earned. For 2025, this fund DID meet the threshold requirements for California, Connecticut, and New York, which require that 50% of the fund’s assets at each quarter-end within the tax year consist of U.S. government obligations.
In comparison, the Vanguard Treasury Money Market Fund (VUSXX) had a GOI percentage of 100% in 2025. (For reference, it was 100% on 2024 and 80.06% in 2023.) If your marginal state income tax rate was 10% that would be a $100 tax savings for every $1,000 in total interest earned.
The total income return for Vanguard Federal Money Market Fund (VMFXX) was 4.22% and Vanguard Treasury Money Market Fund (VUSXX) was 4.23% over the 12-month period of 2025, meaning the pre-tax return was basically the same. This is why many people chose to manually buy VUSXX instead of the default settlement fund as it can earn you a higher after-tax interest rate.
(Why doesn’t Vanguard let you use VUSXX as your cash sweep? Most likely due to the many inflow and outflows of a cash sweep, those liquidity concerns make it hard to hold everything in Treasury bonds. I’m guessing that repurchase agreements are more liquid.)
The following Vanguard funds and ETF equivalents have 100% of their interest from US government obligations:
- 0-3 Month Treasury Bill ETF (VBIL)
- Ultra-Short Treasury ETF (VGUS)
- Short-Term Treasury Index Fund (VGSH, VSBSX)
- Intermediate-Term Treasury Index Fund (VGIT, VSIGX)
- Long-Term Treasury Index Fund (VGLT, VLGSX)
- Extended Duration Treasury Index Fund (EDV)
- Short-Term Inflation-Protected Securities
Index Fund (VTIP, VTAPX) - Inflation-Protected Securities Fund (VIPSX, VAIPX)
Note that several other Vanguard funds have a lower but nonzero percentage of dividends from US government obligations, including the popular Vanguard Target Retirement 20XX funds (up to 33-34% for Target Retirement 2020 and Target Retirement Income!). Definitely worth a closer look for residents with high state/local income tax rates, especially those closer to retirement (holds more bonds).
To obtain these tax savings, you’ll have to manually adjust your state/local income tax return. I don’t believe that TurboTax, H&R Block, and other tax software will do this automatically for you, as they won’t have the required information on their own. (I’m also not sure if they ask about it in their interview process. You may need to click on certain spot.) If you use an accountant, you should also double-check to make sure they use this information. Here is some information on how to enter this into TurboTax:
- When you are entering the 1099-DIV Box 1a, 1b, and 2a – click the “My form has info in other boxes (this is uncommon)” checkbox.
- Next, click on the option “A portion of these dividends is U.S. Government interest.”
- On the next screen enter the Government interest amount. This will be subtracted from your state return.
Standard disclosure: Check with your state or local tax office or with your tax advisor to determine whether your state allows you to exclude some or all of the income you earn from mutual funds that invest in U.S. government obligations.
[Image credit – Tax Foundation]