Alternative Minimum Tax And Effective Returns From Municipal Bonds

Taxpayers must pay the alternative minimum tax (AMT) if a minimum tax rate applied to a broad measure of income results in an amount greater than the regular tax. The AMT rate is 20 percent for corporations and 24 percent for other taxpayers. Currently, this broad measure of income includes 100 percent of private activity bond interest and, for corporations, encompasses up to 75 percent of other tax-exempt interest. This paper explains the computation of the AMT and shows the effect of the AMT on after-tax yields from investment in municipal securities. In particular, it demonstrates that the after-tax return on municipal bonds declines with an increase in the number of years until the AMT credit resulting from previous years AMT paid is utilized. The paper then analyzes the AMT in terms of the tax clientele it creates and the implicit tax it may reduce.