Q&A: Municipal bonds and the alternative minimum tax

September 19, 2008

I'm thinking about adding some municipal bond funds to my portfolio. But I remember hearing some-thing about munis being affected by the alternative minimum tax. Can you clarify?

Q: I'm thinking about adding some municipal bond funds to my portfolio. But I remember hearing something about munis being affected by the alternative minimum tax (AMT). Can you clarify?

A: Income on most municipal bonds escapes federal tax (and state tax, in some cases), even if you're subject to the AMT. But certain types of munis, called "qualified private activity bonds," can be an exception. They're typically issued by state or local governments, and a portion of the proceeds funds special projects that benefit private enterprises. If you own such bonds, either directly or through a mutual fund, you may owe federal tax on the income from them if you get hit with the AMT. You might want to check with your accountant before investing in funds that include these types of bonds.