The AMT and Muni Bonds
Even after April 15, investors who own certain types of municipal bonds should be aware of potential Alternate Minimum Tax (AMT) liabilities.
AMT is a separate tax computation under the Internal Revenue Code that, in effect, eliminates many deductions and credits and creates a tax liability for an individual who would otherwise pay little or no tax. In recent years, more and more people have found themselves subject to the AMT.
The unique feature that sets municipal bonds apart from all other capital market securities is that the interest earned on them is exempt from federal income taxes. Also called “tax exempts” the interest on bonds issued in one state is also usually exempt from that state’s income taxes, and in some cases from local income taxes.
Municipal bonds, securities sold by state and local governments to finance capital projects, are also issued for purposes that are outside the realm of pure governmental functions. Such bonds include those issued for not-for-profit 501(c)(3) organizations and other “private activity” issuers such as airports and certain types of housing agencies.
“Private activity” municipal bonds are subject to the federal alternative minimum tax. In 1986, the Tax Reform Act required that interest on private activity bonds (other than 501(c)(3) obligations) issued after August 7, 1986 be included in the calculation of AMT income for federal tax purposes.
According to the IRS Web site, for 2008 the exemption amounts for figuring the AMT have increased, and this amount depends on your filing status. You may have to pay the AMT if your taxable income for regular tax purposes, combined with certain adjustment and tax preference items (including interest on certain private activity bonds), is more than the following exemption amounts below:
- $69,950 if you are married filing a joint return or a qualified widow(er),
- $46,200 if you are single or head of household, or
- $34,975 if you are married filing a separate return.
Given that they may be taxable, why would anyone buy AMT bonds, versus non-AMT bonds?
The yields on AMT bonds are higher, reflecting the risk that they could become taxable to some investors at some point in time. If an investor purchased an AMT bond before he or she became subject to the AMT, the investor achieved a higher yield at that time than if he or she had purchased a non-AMT bond. However, as financial circumstances may change over the years, investors may find that they are now subject to this tax.
How does this affect the municipal bond holder?
Most individuals hold municipal bonds in one of two ways–either they own the bond outright, or they own municipal bond funds.
How can you tell if the interest on the bond or the bond fund that they own is subject to the AMT?
Determining if an individual bond is subject to AMT is fairly simple, and there are several places to find this information. When you purchase a bond, a confirmation is sent to you, which includes many identifying details about the security, including the name, maturity and whether the income is subject to the AMT. If the bond was purchased in the primary market, an official statement was sent to you. The front cover of the official statement will tell you if the bond is subject to the AMT. If you maintain an account at a securities firm, you should be able to find out that information from your account representative. If you know the CUSIP number, you can also access the AMT information.