Don’t expect any real relief from the alternative minimum tax (AMT) anytime soon. And Wall Street is finally sitting up and taking notice.
Strategy: Look into new mutual funds designed as “AMT-free.” In a twist from previously offered tax-exempt mutual funds, these new financial products don’t invest in bonds that could cause AMT complications.
But the new AMT-free funds aren’t for everyone. Some investors may come out ahead by buying other bond funds, even if they end up getting hit by the AMT!
First, here’s a brief recap: The AMT is a separate calculation that you must run side-by-side with your regular income tax figures at tax return time. The AMT starting point is your taxable income for the year. Next, you add in certain “tax preference items” and make other technical adjustments. Then you subtract a special exemption amount based on your tax return filing status.
Finally, you apply the AMT rate to the remainder, and compare it to your regular income tax bite. In effect, you pay the higher of the two. The AMT rate is 26 percent for the first $175,000 of AMT income; 28 percent above that.
What are the tax-preference items and adjustments? The list is long (see box). Example: A potential trap facing investors: Exempt interest from private-activity bonds (PABs) must be added to AMT income. Those include municipal bonds that fund private activities like sports stadiums. That add-on could be enough to trigger the AMT.
But you may be able to sidestep this trap by investing in AMT-free funds. Some heavy hitters on Wall Street advertise funds that invest in short-term obligations while barring investments in PABs. Other funds don’t make a big deal about avoiding AMT liability, at least not yet. Check your fund’s prospectus or call the fund company to determine your potential exposure.
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