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High Net Worth Investors Suffering Under The AMT

by Mike Godfrey, Tax-News.com, Washington

09 July 2001

High net worth investors in the States are suffering the effects of the unpopular Alternative Minimum Tax already, it was revealed recently, as many who sought the shelter of tax free municipal bond funds are finding that they may have to pay tax on the income after all.

The AMT is a poorly thought out alternative to the regular income tax system, which forces taxpayers to compute their tax bills twice; once in the normal way, and once at a slightly lower rate, but without being able to take advantage of many of the existing exemptions. They must then pay whichever total is higher. Unlike many other taxes, it was not indexed to inflation in President Bush's new tax bill, and so many more investors are being affected by it, with the number set to peak at 35.5 million American taxpayers in 2010, unless something drastic is done.

The reason that this is now starting to affect wealthy municipal bond investors is that although the income on most minicipal bonds carries no tax, certain kinds of securities, known as private purpose bonds, are taxable. These bonds are backed by private enterprises, and can be floated to pay for all kinds of projects. A fund manager can pick up approximately 20 basis points of extra income from these (as opposed to a similar quality municipal bond). Because of ths, they have become increasingly popular with fund managers, who have reasoned in the past that as relatively few investors were subject to AMT, so the vast majority were still getting a completely tax free income, but with better returns.

However, this is sadly no longer the case, and with more and more taxpayers set to become victims of the AMT, the boost that private purpose bonds can bring to a portfolio may no longer be enough to offset the risk of triggering the alternative tax. 'Our high net worth shareholders have made it very clear that they don't want bonds in their portfolio that are subject to AMT,' said one bond fund manager.

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