Same Yield Can Be a Different Tax Bill

In February of 2025, we wrote about a tax mistake worth avoiding: interest from Treasuries can be, depending on the scenario, exempt from state income tax, but fund 1099s don’t break it out, so the adjustment is on you. For anyone holding a fixed income fund with a Treasury allocation, please read that post. But that post was about getting the paperwork right. This one is about a fund that doesn’t qualify no matter how carefully you file.

Schwab runs the Schwab U.S. Treasury Money Fund (Ticker: SUTXX) and the Schwab Treasury Obligations Money Fund (Ticker: SCOXX). Both carry the same 0.19% expense ratio and, as of October 31, 2026, roughly the same yield (3.76% and 3.75%). For 2025, 99.99% of the first fund’s income came from U.S. Treasuries. For the second, 31%. The U.S. Treasury fund owns Treasury bills, while the Treasury Obligations fund keeps about two-thirds of its assets in repurchase agreements, which are loans to dealers backed by Treasuries, and states tax that income.

In most states with an income tax, the exemption is simply proportional: essentially all of SUTXX’s income is state tax exempt, while only 31% of SCOXX’s is. Three states, California, Connecticut, and New York, add a second test under their own tax law: the fund has to hold at least 50% of its assets in U.S. government obligations at the end of every quarter of its fiscal year. Miss it once, and none of the income is exempt in those states (not a smaller share... zero). SCOXX fails that test, so a California client with $500,000 in it pays about $1,700 a year of state tax on income that would have been fully exempt one fund over, at approximately the same yield. The Schwab Government Money Fund (Ticker: SNVXX), another $85 billion, came in at 36% and fails the same way.

What the 2025 numbers show

Most fund sponsors publish a supplement each January or February showing what share of the prior year’s dividends came from U.S. government obligations. We believe the 2025 numbers show a simple pattern.

• Funds that can only hold Treasury bills and notes came in near 100%.

• Government funds that are also allowed to hold repurchase agreements came in lower, with many below 50%.

What it costs

Take $500,000 of taxable cash earning 4%, or $20,000 of income. A California filer in the 9.3% bracket owes $1,860 of state tax on that income if the fund failed the test, $621 if it passed at 67%, and $0 in a Treasury-only fund. A New York City resident paying state and city tax owes $2,145, $716, or $0. That is every year, on money that often sits for years, and this year the Treasury-only funds have generally yielded about the same as the sweep funds.

Where things stand for 2026

The 2026 percentages won’t be published until early 2027, but for most funds there is no suspense. The Schwab Treasury Obligations fund had about 63% of its assets in Treasury repo at June 30, a fiscal quarter-end (and about 65% at the end of August), so it already sits far below the line, and the same goes for the Schwab Government fund and for every prime fund, which hold bank and corporate paper by design. The funds that keep the question open are the government money funds that hover between 50% and 70% and move with the repo market. Those can pass one year and fail the next, and the sponsor doesn’t say which until the supplement comes out in February. A Treasury-only fund is 99% to 100% Treasuries every month and has nothing to wait for.

Credit isn’t paying you enough

There is a second reason to lean on Treasuries in a taxable account right now: with credit spreads this narrow, the extra yield doesn’t cover the extra tax. Three-month commercial paper yields within five basis points (a basis point is one hundredth of a percentage point) of a three-month bill. Prime money funds, which own that paper plus bank CDs and time deposits, pay 3 to 16 basis points more than their Treasury-only siblings. In a 9.3% state bracket, the Treasury fund’s exemption is worth 30 to 35 basis points. So the prime fund takes more risk, can impose a liquidity fee in a stressed market, and nets less after tax.

The same math runs through the core bond allocation. The Agg index (the Bloomberg U.S. Aggregate Bond Index, the standard benchmark for U.S. investment-grade bonds) is a little under half Treasuries, with the rest in agency mortgages and corporate bonds, and the two largest Agg index funds reported 41% and 44% of their 2025 income from U.S. government obligations. Both fail the three-state test, so in California, Connecticut and New York every dollar of their income is state-taxable. As of October 31, the iShares Core U.S. Aggregate Bond ETF (Ticker: AGG) yields about 5.50% to maturity against 5.14% for a Treasury index ETF of the same duration, a 37 basis point pickup for taking on mortgage and credit spread risk at the tight end of the range. After a 9.3% state tax, the Agg fund nets about 14 basis points less than the Treasury fund in those three states, and keeps only about 7 of the 37 everywhere else. At these spreads, the taxable half of the Agg isn’t paying enough to cover its own tax bill, let alone the risk, in our opinion.

Points to consider

• Know what the sweep is at each custodian and look up its percentage. Schwab defaults to a bank deposit, and its money fund menu runs from 0% exempt to 99.99% exempt depending on which one you pick. Fidelity and Vanguard default to government money funds whose exempt share depends on how much repo they held that year. For a client in California, Connecticut, or New York with meaningful taxable cash, the default can be a tax decision somebody else made.

• For taxable cash that will sit for more than a few weeks, consider a fund whose mandate is Treasuries: a Treasury-only money fund or a short Treasury bill ETF. They clear the test with room to spare, pass through 95% to 100% of their income, and at today’s spreads they give up nothing to prime funds after tax.

• Keep doing the reconciliation. Some custodians now print the percentage in the 1099 supplement. None of them enter it on the state return for you. If it was missed on a 2025 return, an amended state return may recover it.

None of this matters in a non-taxable account such as an IRA, and none of it matters in a state without an income tax. Everywhere else, the exemption is federal law. Whether your client actually gets it is a fund selection.

Disclosures

This blog post is for informational purposes only and does not constitute tax advice. Please consult a qualified tax professional for guidance specific to your situation.

Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward-looking statements cannot be guaranteed.

Fund percentages cited are as published by the respective fund sponsors for tax year 2025 and change annually. Holdings data is from SEC Form N-MFP filings and fund sponsor reports as of the dates shown. Fund yields are from SEC Form N-MFP (money market funds, 7-day net yield at October 31, 2026) and YCharts (yield to maturity at October 31, 2026); commercial paper and Treasury bill rates are from the Federal Reserve H.15 release (October 29, 2026); yields change daily. Funds are named as published examples and are not recommendations to buy or sell any security. The tax figures are a conceptual illustration, use a single state marginal bracket, and ignore federal taxes, local taxes except where noted, offsetting items and individual circumstances.

Information presented as a conceptual illustration in the above images is for illustrative purposes only and should not be interpreted as actual performance or tax outcomes of any investor’s account. These figures are entirely assumed to illustrate the concept. As these are not actual results and are completely assumed, they should not be relied upon for investment decisions. Actual results of individual investors will differ due to many factors, including individual investments and fees, client restrictions, the timing of investments, tax circumstances, and cash flows.

This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy.

Investing involves risk. Principal loss is possible.

Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2611-13.