If you bought municipal bonds for their tax-exempt status, it may be time to rethink them--or at least re-examine the fine print on the bond offering. For the increasing number of taxpayers subject to the Alternative Minimum Tax (AMT), the tax-free status of many munis--which is their main attraction--gets nullified.
In short, not all munis are created equal, explains Bob D. Scharin, RIA senior tax analyst at New York City's Thomson Tax & Accounting. "Some localities issue [qualified] private-activity bonds, which finance the activities of nongovernmental bodies," he says. "In those cases, the interest might be tax-free for regular tax purposes, but not for taxpayers subject to the AMT."
How do you spot a private-activity muni? Bonds issued to finance building a sports stadium or an airport--projects that are backed by localities seeking to boost employment or a local economy, but are essentially private activities--generally won't be exempt. Traditional municipal issues, however, will. "Look for that information in the bond materials, or ask your broker if the bond is not subject to the AMT," advises Scharin. "And if you already own muni bonds but have recently crossed the threshold to be subject to the AMT, it may be time to consider a more appropriate investment vehicle."