Unlocking State Tax Benefits: Understanding Vanguard Money Market Funds

As tax season rolls around once more, savvy investors possess a valuable tool in maximizing their returns – investment in money market funds, particularly those offered by Vanguard, which can provide significant state income tax exemptions. If you have invested in a Vanguard money market fund, such as the Vanguard Federal Money Market Fund (VMFXX) or the Vanguard Treasury Money Market Fund (VUSXX), you may qualify for exemptions on interest earned from U.S. government obligations.

Decoding Tax Exemptions

The financial landscape often appears complex, particularly when navigating tax returns. Yet, claiming a state income tax exemption on the interest earned from certain Vanguard money market funds is straightforward, provided you have the necessary information. For instance, the IRS Form 1099-DIV will report ordinary dividends which may be partially exempt if derived from U.S. government obligations.

For tax year 2025, the VMFXX fund reported that 66.61% of its dividends came from U.S. government obligations. This means if you earned $1,000 in interest from this fund, $666.10 may be exempt from state and local income tax. When considering a marginal state income tax rate of around 10%, this translates into approximately $67 in tax savings per $1,000 earned. Such benefits become particularly striking for residents of California, Connecticut, and New York where specific thresholds are mandated for exemption eligibility.

Comparative Analysis: VMFXX vs. VUSXX

Investors comparing Vanguard's money market offerings often favor the VUSXX due to its higher government obligation percentage, which was 100% in 2025. This distinction makes VUSXX particularly appealing for investors seeking the maximum tax benefits, yielding the same returns while providing greater tax exemption potential.

The VMFXX returned a total income of 4.22% in 2025, while VUSXX offered a slightly higher return of 4.23%. Given these similar returns, many investors are leaning toward treasury funds to optimize their after-tax interest rates. Notably, it’s the percentage of tax-exempt income that ultimately impacts investor choices.

Choosing the Right Fund for Your Needs

Vanguard offers various money market funds tailored to diverse investment goals, and it’s crucial to understand the distinctions between them. Vanguard’s funds covered include:

• 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)

Each of these funds varies by the type of securities they hold, affecting both the returns and their tax implications.

Actionable Insights for Investors

Investors must remain proactive about tax electoral choices. Given the complexities of state tax regulations, consider consulting a tax advisor or financial planner to maximize these benefits. For example, to accurately report state income tax exemptions when using TurboTax or other software, you may need to manually adjust entries based on the 1099-DIV information you receive. It’s critical to carefully navigate these tax features to ensure you are maximizing your returns.

Time is of the essence; starting to prepare your tax documents now and understanding your investments can lead to significant savings come April. Engage with your financial advisor to review your investment portfolio and ensure that state income tax exemptions are thoroughly understood and applied.

In a high-interest rate environment, as witnessed throughout 2025, money market funds not only serve as safe havens for liquid cash but also potent vehicles for tax-free growth. Proper knowledge about your investments can lead to informed decisions and increased financial advantages.

Consider taking the time to explore these funds and how they fit into your broader investment strategy. Proper planning can unlock substantial benefits that enhance your fiscal health.