Treasury Bonds & AMT

AMT is an odd thing, and the simple answer to your question is 'yes', but for that matter, tax-free munis can also be subject to AMT.

AMT is more about what you cannot take as a deduction than what you have to may tax on, in my view. I find that all of my property tax does not reduce my tax liability, nor does much of my state tax. And my LT cap gains are taxed at 22.5%, not

15%. That's my incentive to funnel highly appreciated stock through a charitable trust fund (Schwab or Fidelity both offer these) to make my charitable donations go further. I can send that 22.5% to Uncle Sam or to the Shelter for Homeless Vets, simple choice for a bit of paperwork.

AMT is far more convoluted than anyone here is likely to describe, I suggest you look at

if you have a follow up query, come back. I also continue to recommend a copy of TurboTax, to play with the numbers and see how any income or deduction actually impacts your tax liability. It was this process that made the taxation of Social Security payments pretty clear to me, and a nice chart came out of that.JOE

Bill, the lack of info from googling may be in the phrasing of your question...the answer is yes, Treasury bond interest is subject to AMT, the only break it receives is exemption from state & local income taxes.

Or put in a more technical way: there are no preference items (adjustments to the computation of taxable income, when computing AMTI) associated with Treasury bonds. If you have $500 in T-bond interest on your regular tax return you'll have the same $500 included when computing your AMTI (alternative minimum taxable income).

Not that you asked but...some municipal bonds whose interest is tax-exempt under the regular tax are taxable under AMT. This is an AMT preference item: "when computing AMTI, start with your regular taxable income and add in any interest from private-activity municipal bonds." For someone in the AMT who holds munis (individually, or through mutual funds or money market funds) that's something to keep an eye on...you think your bond is tax-exempt, so accept a lower interest rate, then find out it's actually taxable under AMT.

-Tad

This has been a surprise for some fund holders where it's not obvious beforehand what kind of muni bonds a fund may hold. Several fund houses are now being more careful about this and about letting folks know what to expect.

ie. Fidelity's Tax-Free Bond Fund (FTABX) and T.Rowe's Tax-Free Income Fund (PRTAX). Vanguard has specifically stopped investing in private activity bonds in 13 of its muni bond funds (though their high-yield one and all of the "tax-free money market" funds continue to invest in private activity bond!).

There are others, but the point is - don't just asssume - check specifically on your fund.

There's a nice piece which talks about this and also lists quite a collection of closed-end funds (an enormous amount of muni-bond fund investing is via CEFs) an article I found at TheStreet.com. Google for "Your Funds Might Be Exposed to the AMT"

[not that I collected all that much muni money market income this year, but now I'm a little bit concerned...]

Just to be clear, interest from US treasury bonds IS subject to the AMT but there are some bonds (specificially municipal bonds, it sounds like) which are NOT subject to AMT. So how do you tell whether or not your specific bond is subject to the AMT? I guess the question is much more complicated for bond funds, which is what you guys have been talking about.

Honestly, I'm floored by the answers I'm getting. How is it consistent that interest from treasury bonds is subject to the AMT but not interest from (certain) municipal bonds? That just blows my mind. It seems utterly arbitrary and capricious.

Thanks, Bill

Interest from US Treasury bonds is subject to *regular* federal income taxes. Things which raise flags for AMT are generally things which are NOT subject to regular federal income taxes but which suddenly become taxable under AMT.

The place where interest from treasury bonds is treated special is on your *state* income taxes.

The term you're looking for is "preference items".

Simplified story:

When you figure out your income for federal tax purposes, you add up all the income, then subtract various deductible items and figure out the taxes you owe based on that imcome. Then, when you figure up the AMT, you add some of those deductible things *back* to your income and recalculate your taxes (with the AMT schedule).

Since you never deducted US Treasury bond income from your income in the first place, you don't add it back when you do the AMT.

For municipal bonds, a specific subset of them - "private activity bonds" - are exempt from taxes on normal federal taxes, but *not* under AMT. So you add them back during that second step.

For bond funds, the fund company will tell you what portion of their distributions are from those bonds. But if you're concerned about it, choose one of the funds which avoids all the private activity bonds.

Because, as I said, interest from treasury bonds is taxed by the federal income tax whether you pay AMT or not. Perfectly consistent.

Muni bonds are not normally taxed by the federal government unless you get hit by the AMT. The part which seems inconsistent is that some but not all muni bonds get this benefit.

In my opinion: If the private activity bonds benefit the public, they should simply be treated, taxwise, like any other muni bonds. And if they don't, they shouldn't. Their treatment shouldn't vary based on whether you are hit with AMT or not.

But my opinion has little bearing on the reality of taxes.

I am so embarassed. I didn't realize this was the case. I don't know how I got it stuck in my head that interest from treasury bonds wasn't subject to federal income tax. I guess it's clear I've never owned any treasury bonds. Thanks for setting me straight.

And given that, the AMT situation regarding bonds seems pretty straightforward, as well. The magic phrase to look for is "private activity". As I get older and start diversifying in to bonds, I'll be sure to keep an eye out for that.

Thanks again, Bill

I am so embarassed. I didn't realize this was the case. I don't know how I got it stuck in my head that interest from treasury bonds wasn't subject to federal income tax. I guess it's clear I've never owned any treasury bonds. Thanks for setting me straight.

And given that, the AMT situation regarding bonds seems pretty straightforward, as well. The magic phrase to look for is "private activity". As I get older and start diversifying in to bonds, I'll be sure to keep an eye out for that.

Thanks again, Bill

There are a variety of weirdnesses re taxation of bonds. And it can be very messy. Everything from munis taxable by the state but not the federal gov't, treasuries taxable by the feds but not the state, OIDs, cap-gains (taxable even on otherwise tax-free munis), etc. etc.

It's surprising anyone can keep any of this straight.

Morningstar's got a nice primer on fixed income taxation:

Kips also has an article in the Dec'07 issue (p.48) - "The ABCs of MUNIs" but, frankly, it glosses over most of the AMT issue.