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Q

Would you explain the criteria for applying Alternative Minimum Tax (AMT) and how it’s applied? Also, now that the IRS requires that you must add tax-free income to your gross and adjusted income and figure taxes both ways, “tax free” isn’t going to be “tax free” and people will no longer buy tax-free bonds. Am I, and millions of others, missing something? No one seems to be concerned – at least few, if any are talking about it – including your own organization! How are state, county, etc. governments planning to fund their tax-free shortfall? Your response would be sincerely appreciated – not only by me, but by the millions of others who also read and admire your balanced commentaries.

A

James A. Klotz responds:

We hope we can clarify some of your thoughts about the Alternative Minimum Tax and its ramifications for municipal bond investors.

First, we recommend you catch up on the latest AMT news, “New AMT Plan Would Benefit ‘Private Activity’ Bondholders”. Our primer on the AMT, “The AMT and What it Means to Bondholders” , will answer your questions regarding the criteria for calculating the AMT and determining whether you are subject to this tax.

We’re not clear who the “millions of others” are who you feel are missing something, but we think you could be.

You are not correct in assuming that no one seems to be concerned about this issue. It has been a hot topic for muni investors for some period of time.

As a matter of fact, if you visit our Web site and type AMT into our search bar, you will access about 15 articles on this subject. We have been cautioning investors about the AMT since early in 2001, when we categorized the AMT as a “time bomb.”

In our article “Beware of Congressmen Bearing Gifts” we opined that the lowering of conventional tax brackets proposed by the Bush administration would have the unintended consequence of subjecting an increasing number of taxpayers to the AMT.

The good news is that the interest from only some tax-exempt bonds is subject to taxation for AMT taxpayers.

These “private activity” bonds are issued for purposes as diverse as housing, airports, pollution control and football stadiums. They are known in our industry as “AMT bonds.” It should be quite simple to determine if you own any, since securities regulation requires an AMT disclosure on applicable investor confirmations.

Remember: Interest from your “non-AMT” bonds continues to be 100% free from federal taxation.

If you own AMT bonds, it is imperative they be converted to non-AMT securities as quickly as possible to avoid sacrificing up to 28% of the income they produce.