We need a pro to tell us the story about whether or not the market discount is exempt from state tax and if so what states that applies to. That's the bottom line I think.
FWIW
I just tried entering one of the bonds that fits the example I posted above into TT Deluxe 2022 which is the latest version I have installed now.
I filled in boxes 1a-1f on the 1099-B.
The difference between the cost and maturity value shows up as ordinary interest on both the federal form and on the NY tax form. No adjustment for exempting the interest is shown on the NY Tax form it is just shown as ordinary fully NY taxable interest. I would not expect it to because it doesn't know if the bond entered is a NY tax exempt Treasury security or not. I assume you will have to tell IT whether it is exempt or not. TT does not know and at the moment neither do I.
Box 1f did not have any effect on the NY interest amount. It stays the same no matter what number that box contains. But it does affect the federal return. I assume this is because the federal return treats interest and capital gains differently, but the NY return does not.
The federal return shows the amount of 1f on Schedule B Part I Interest on a separate line labeled "Bond Accrued Market Discount" (as expected).
My guess is that the market discount is not state tax exempt, maybe not in any state that has an income tax. My reasoning is this. The market discount is not income paid to you by the issuer of the instrument, it is simply based on a price set in the marketplace. So if it isn't paid to you by the government, which has a special exemption from state taxes for income paid to you, why should it not be subject to state tax? Or is that too logical for the people who write the tax code?
That is just speculation of course. There is a way to put in the exemption on the NY form, so if it is applicable that is how I would enter it. But the question is still open.
Maybe the discount is exempt in some states... but maybe not.
Still an open question, but this test shed some light on things at least for me.
