Transcripts

"Kevin McCormally's Tax Tips" - AMT & Municipal Bonds

SUSIE GHARIB: Well, just 36 days away from April 17, the deadline for filing your 2006 Federal income taxes. To help you get prepared, we'll have some tax advice every Monday night for the next five weeks. In tonight's tax tips, Kevin McCormally, editorial director of "Kiplinger's Personal Finance," says when it comes to tax-free muni-bond investments, beware the AMT.

KEVIN MCCORMALLY, EDITORIAL DIR., "KIPLINGER'S PERSONAL FINANCE"" Investors are getting a nasty surprise this spring. Income they thought was tax-free is being smacked by Uncle Sam with a 26 or 28 percent tax. Welcome to the topsy-turvy world of the alternative minimum tax and the oxymoron of taxable tax-free municipal bonds.

The municipal bond market is divided into two parts: public-purpose bonds and private-purpose bonds. Interest on public-purpose bonds, used to build schools, for example, is indeed tax-free. Interest on private purpose bonds, used to finance a sports stadium perhaps, or industrial project, is tax-free, too, unless you're subject to the AMT. For taxpayers trapped in that parallel tax universe, interest on these tax-frees is fully taxable at 26 percent or 28 percent. This has been the rule for a couple of decades, but it's really coming home to roost this year for a couple of reasons.

First, more people than ever are falling victim to the AMT. Second, because of reason number one, Congress ordered that brokers and mutual funds start separately reporting private-purpose bond interest on the 1099 forms that go to investors and to the IRS. That's why millions of forms were late this year. Brokers and funds had trouble getting the extra info. You'll find it on line nine of your 1099-int. Now, if part of your tax- free interest is hit by the AMT this year, you've got to pay the piper. Going forward, though, you might want to move your tax-free money into a bond fund that promises to avoid private-purpose bonds. I'm Kevin McCormally.