Municipal-Bond Funds Still No Escape From Tax Planning : Investments: Many owners learn too late that tax-exempt doesn’t always mean tax-free. Now’s the time of year to watch out.

As many owners of municipal-bond mutual funds are discovering, tax-exempt investing is not always tax-free investing.

One of the prime attractions of muni-bond investments is the freedom they enjoy from federal income tax on the interest (or dividends, in the case of municipal-bond funds) they pay.

But as people focus on that attribute, they can easily forget that municipals’ tax-sheltered status does not necessarily extend to such other levies as capital gains and state and local taxes.

Right now, in the waning weeks of a year, financial advisers say it is especially important for people investing in a municipal bond fund to watch out for tax traps.

“Many individuals, new to this type of investment, have believed that all of the dividends they received would be completely exempt from taxation,” says the Value Line Investment Survey in a current bulletin. “Unfortunately, that’s not entirely accurate.

“It is true for dividend distributions paid out to shareholders from interest income derived from the funds’ municipal bond holdings. But the law also requires mutual funds to annually pass on to their shareholders the net realized capital gains accrued during the past 12 months.”

Capital gains--profits realized from selling bonds for more than the price paid to buy them--aren’t a big issue in years when bond prices have stagnated or declined.

But they have been a major factor in 1992 and again this year, because bond prices have climbed sharply while interest rates have fallen.

In addition, the tax and budget bill enacted this year requires that gains on bonds bought after April 30 of this year for prices below their original issue price be treated as ordinary income, rather than capital gains.

“The taxable distributions usually happen under favorable circumstances,” notes the Benham Group, a firm that manages a fund family including both national and California-only muni funds. “But they understandably attract attention simply because they are taxable instead of tax-free.”

Benham recently advised its investors that it expects to make taxable distributions to holders of seven muni funds as of Dec. 14.

“Most funds will make known the amount and date of an expected capital gains distribution some weeks in advance of the actual declaration--and before the all-important record date,” Value Line points out.

This can help to avert surprises. Perhaps more important, it can serve as an alert to help new investors avoid a pitfall that also may arise with stock funds or any other fund that realizes capital gains.

People who buy just before a capital gains distribution--but after most of those gains have pushed up the fund’s net asset value--effectively get some of their own money returned to them, with a tax obligation tacked on to it, when the distribution is made.

“It’s easy enough for savvy investors to avoid the capital gains trap,” Value Line notes. “Before investing, it’s wise to make a phone call to find out whether any intended distribution will be large enough to make it worth waiting until after the record date before making an investment in a particular fund.”

State and local income taxes also are a point to consider in any fund that owns municipal securities issued by entities outside the state where you live.

“These funds annually provide an analysis of how much of their earnings came from each state,” notes Bob Kamman at the National Taxpayers Union in Washington.

“If your state accounted for only 5% of a fund’s income, you must pay state tax on the other 95% of the fund’s dividends.

“Purists will point out that this last statement is not entirely accurate. Income from bonds issued by U.S. possessions--Puerto Rico, the Virgin Islands, Guam--is not subject to tax in any state.

“So if 5% of your fund’s income came from your home state, and 1% came from Puerto Rico, pay state tax on 94% of what you received.”