The interest payments generated by most bonds are taxable as ordinary income. That’s why the best place to own bonds is within a tax-deferred account.

However, if you sell a bond or bond fund, you’ll be taxed on the capital gain (your profit), if any, from that sale. Currently, the long-term capital gains rate – for investments held more than a year – is 15%. Short-term gains are taxed as ordinary income.

There are some caveats. Municipal bonds aren’t subject to federal taxes; if you own a “muni” issued by a municipality in your own state, you may also avoid state and local taxes. Munis usually pay a lower interest rate, but some people come out ahead given the tax advantages (that’s why folks in high tax-brackets invest in them).

If you’re subject to the alternative minimum tax -- the parallel tax system that was put in place to ensure fat cats paid their fair of taxes but now stings a growing portion of the middle class – it gets a little more complicated. Some municipal bonds – or those that fund private projects like a sports stadium – may be subject to the AMT, while bonds issued to fund public projects (like roads, airports) are not.

Government-issued bonds (like Treasurys and other government-agency debt) are subject to federal taxes, but not state or local. Corporate bonds are fully taxable.