Q: Is there a way to invest in municipal bonds and keep the income free from the alternative minimum tax? I know of tax-sensitive funds that may or may not fit the bill, but I am interested in individual "munis." M.B., via e-mail
A: The market for municipal bonds is mammoth, and there are indeed a number of individual issues around that are not subject to the alternative minimum tax, or AMT, says Darin Richards, chief investment officer with Wealth Advisors in Lake Oswego, Ore. You'll just have to have your financial adviser select one that suits your needs and style, he says. If they're AMT-free, they'll be identified as such.
Some municipal bond mutual funds are restricted from holding bonds that are subject to AMT. You can look at their list of holdings to get a flavor of the kinds of bonds that interest you.
AMT, initiated in 1969, is a tax designed to prevent taxpayers in the higher income brackets from reducing their tax bills via "excessive" exemptions and deductions. It has recently risen in visibility because the number of taxpayers subject to the tax has increased dramatically over the past few years, and it is expected to affect approximately 30 percent of all taxpayers by 2010.
Municipal bond interest, which is typically viewed as tax-free, may be subject to AMT in specific situations. Interest earned from private activity bonds, which are issued to finance specific projects, is subject to taxation via AMT. Generally, AMT bonds pay a slightly higher yield, but Mr. Richards says that it is not enough to compensate investors subject to AMT.