For years, the IRS has been tracking taxable interest to make sure taxpayers report it on their returns by requiring payees to issue 1099s. However, tax-exempt interest, such as interest from municipal bonds, has never been included in the 1099 reporting requirement. This changes beginning with the 2006 tax year. Payers will now be required to report to the IRS tax-exempt interest that they paid to others.

Why did Congress add this requirement in the new tax law? Although the tax-exempt interest is not subject to federal income tax, it is included in the computation of taxable Social Security benefits and the Alternative Minimum Tax (AMT). This new reporting requirement will prevent taxpayers from being able to omit tax-exempt income from their returns and avoid additional taxes on their Social Security income and/or increased AMT.