Private Activity Bonds

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 10

Tuesday, December 29th, 2009 | Print This Post Print This Post | Email This Post Email This Post

Year-End AMT Planning Wrap-Up – Part 2

The AMT items that were talked about in Part 1 of this wrap-up generally were the bigger ones that can, depending on a taxpayer’s situation, present immediate year-end Alternative Minimum Tax savings opportunities. But the other items that were discussed in this 10-week series also are important in making sure the least amount of AMT is paid. Here is a brief recap of these other items, with references to the amtblog.com articles in which each appeared.

Investments: Private Activity Bonds – an individual investing in tax-exempt municipal bonds can receive an unpleasant surprise when he discovers that AMT has to be paid on the interest income from a certain type of municipal bond. See the December 18th article posted on amtblog.com.

Miscellaneous Itemized Deductions – business or investment-related expenses may be deductible under the Regular Tax, but they are not for the AMT. Several planning ideas on how to minimize this impact are presented. See the November 14th article posted on amtblog.com.

Limitation on Itemized Deductions: AMT Adjustment – when a taxpayer is in the AMT, the limitations that apply to itemized deductions are calculated differently from the limitations that apply for the Regular Tax. See the November 25th article posted on amtblog.com.

State Income Tax Refunds: AMT Adjustment – because of the different AMT treatment of state and local tax deductions, any adjustment to these deductions – for example, a refund of overpaid state taxes which generally is treated as income when received – is itself then given different treatment for the AMT. See the November 29th article posted on amtblog.com.

Standard Deduction – a taxpayer is allowed no standard deduction in calculating the AMT. An interesting planning idea here could mean that an AMT taxpayer might be better off not claiming the standard deduction at all. For a discussion of this opportunity see the November 18th article posted on amtblog.com.

Personal Exemptions – similar to the standard deduction, a taxpayer is allowed no deduction for personal exemptions in calculating the AMT. Not a whole lot can be done here, but there always are at least a few planning ideas. See the November 22nd article posted on amtblog.com.

The AMT Exemption, also known as “the annual patch” – the AMT Exemption amount is set annually by Congress. This is a prescribed amount by which a taxpayer’s Alternative Minimum Taxable Income must exceed his Regular Tax taxable income before the AMT itself is triggered. If Congress were to fail to adjust this exemption amount, 24 million new taxpayers would be pulled into the AMT, in addition to the four-plus million already stuck there. See the December 21st article posted on amtblog.com. Also, pay careful attention to the news we will be seeing on this in the near future as we anxiously await Congress’ fix on this again for 2010.

Good luck with your AMT planning. Hopefully each of these articles provided a simplified explanation along with a few 2009 Alternative Minimum Tax savings ideas. Soon we’ll be working on 2010!

Posted in AMT Exemption, AMT Planning in General, Misc Deductions 2-percent Floor, Personal Exemptions, Private Activity Bonds, Standard Deduction | No Comments »

It’s Fall: 10 Weeks of Alternative Minimum Tax Planning Ideas…Week 8

Friday, December 18th, 2009 | Print This Post Print This Post | Email This Post Email This Post

Investment – Private Activity Bonds

Municipal bonds, or “muni bonds” as they are commonly referred to, offer favorable tax treatment in that the interest earned on them is not subject to tax. This tax-free yield can make them an attractive investment. If an investor is not careful, however, the AMT can apply to make certain muni bonds fully taxable. Unfortunately, many taxpayers discover this only after making the investment.

The general exemption from tax on muni bonds applies only for purposes of the Regular Tax. For purposes of the Alternative Minimum Tax, municipal bonds are divided into two categories – those used solely for public purposes, and those used to support private activities. The latter are called “private activity bonds.”

There are a number of different types of private activity bonds. Here are the descriptions found on the web site of the Municipal Securities Rulemaking Board (MSRB) – the organization that regulates brokers who deal in municipal securities:

Exempt facility bonds – Private activity bonds issued to finance various types of facilities owned or used by private entities, including airports, docks and certain other transportation-related facilities; water, sewer and certain other local utility facilities; solid and hazardous waste disposal facilities; certain residential rental projects, including multi-family housing revenue bonds), and certain other types of facilities. Enterprise zone bonds are also considered exempt facility bonds.

Qualified mortgage bonds – Private activity bonds issued to fund mortgage loans to finance owner-occupied residential property.

Qualified redevelopment bonds – Private activity bonds issued to finance certain acquisition, clearance, rehabilitation and relocation activities for redevelopment purposes by a governmental entity in designated blighted areas.

Qualified small issue bonds – Private activity bonds issued to finance manufacturing facilities in an amount up to $1 million, or higher in certain situations.

Qualified student loan bonds – Private activity bonds issued to finance student loans for attendance at higher education institutions.

Qualified veterans’ mortgage bonds – Private activity bonds issued to fund mortgage loans to finance owner-occupied residential property for veterans.

The main problem with private activity bonds is that the yield the taxpayer earns can be significantly less that what he anticipated at the time he made the investment. For example, assume a taxpayer buys a muni bond paying 4% interest. For a tax-free yield this is a pretty good return. Suppose, however, that this is a private activity bond, and that the taxpayer discovers he is stuck in the AMT. In this case the yield is something less than 3% (4% minus the AMT in the 28% bracket makes the actual yield only 2.88%). Perhaps as an investment this yield isn’t so attractive any more.

The key, as with all planning, simply is to do a little work in advance. The prospectus on any individual bond has to state if it is a private activity bond. For a muni bond mutual fund, the prospectus would be required to tell the investor if investing in private activity bonds is contemplated by the fund.

The AMT is a yield-killer. A little time spent reading or at least inquiring can go a long way towards protecting that precious yield!

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