<nowhere[at]noplace.com> wrote in message news:H8Cve.195$JM6.173[at]trndny05...
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Let's try to separate two issues here:

- How much at risk are you to AMT? That is, how likely are you to be paying
AMT *independent of this particular investment*. If you are paying AMT,
then it doesn't matter whether this is "barely crossing" or not.

The only impact that being close to paying AMT has is that when calculating
the AMT liability of this investment is that you will overestimate the worst
case - that's because you don't pay AMT on the yield that is subject to AMT
but still below your threshold.

Example: You need to add $1500 of AMT income before you become liable for
AMT. You make an investment that produces $2000 subject to AMT (say, a
$10,000 yield, of which 20% is subject to AMT). The first $1500 only brings
you to the point of being liable for AMT, and you owe 26% (AMT rate) * $500
or $130 in AMT.

If you had just estimated your worst case liability, you would have taken
$2,000 * 26%, or $520. So, by being near, but not over, the threshold, you
will overestimate the worst case amount of AMT you would owe.

- Assuming that you are already near, at, or across this threshold, then
does the AMT due on a muni bond fund negate the advantages of that
investment, compared with the net yield on an AMT-free fund, or compared
with a fully taxable fund?

In theory, because (I believe) the spread between munis with and without
AMT-liability is relatively small, an investor already subject to AMT is
better off with bonds that are not subject to AMT. If you were investing in
individual bonds, then your concern would be well-founded.

But when looking at bond funds, you have to consider the funds in the real
world. Vanguard funds have lower expenses, thus producing higher pre-tax
yields (all else being equal). What I showed was that because they are only
(at worst) 20% subject to AMT, Vanguard's advantage in costs more than makes
up for the small AMT you might be paying, compared with funds from other
families that are 100% AMT free, but cost a bit more.

The answer can shift over time, as tax rates change, as interest rates
change, as your personal situation changes. I think one will never lose
much (including AMT) going with Vanguard, but that isn't saying that one
won't ever come out worse.

Alternatives are 100% AMT-free funds (like Fidelity Spartan muni funds).
You likely don't come out ahead relative to the Vanguard funds (even with
their small AMT liability), but you may still come out ahead of taxable
funds.

Vanguard's taxable Intermediate Term Bond Index is yielding 4.31%.
Fidelity's Spartan Intermediate Muni Income fund is yielding 3.20%.

If you are in the 28%+ tax bracket, then the after-tax yield of the Vangaurd
fund is 3.1% or less, i.e. below the Fidelity 100% AMT-free fund.

Bottom line - the particular "best" choice can shift over time, so you are
right to be concerned, but not overly so. If the differences, one way or
the other, become so large, then the "right" choice will likely also become
obvious.
--
Mark Freeland
nBeOwXs[at]pacbell.net

Thanks. I really appreciate the information. My concern about investing in
exempt vehicles is that it might be the straw that breaks the camels back
and pushes me into AMT territory. Just barely crossing that threshold and
having to pay AMT might negate the additional earnings, or is this concern
unfounded?

"Mark Freeland" <nNeEwTs[at]sonic.net> wrote in message
news:42BED275.593[at]sonic.net...
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NW wrote:
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The number will vary from year to year, effectively guaranteed to be
under 20% (otherwise they could not be called "tax exempt" - since
regulations require 80% of a fund's investments to conform to its name,
and "tax exempt" means exempt from AMT as well as ordinary taxes).
http://www.vanguard.com/pdf/icamt.pdf

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Yes.

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Yes, but does it matter? You'll probably save enough with Vanguard's
lower expenses than you would pay in additional AMT. For example, if we
compare Vanguard's Calif. TE MMF (15.6% of the return was subject to AMT
last year), with Fidelity's Spartan Calif. MMF (100% AMT-free), we see:

Vanguard current yield: 2.26%
Fidelity current yield: 2.12%

Amount of Vanguard fund subject to AMT ~= 15.6% * 2.26% = 0.35%
Worst case AMT liability = 28% * 0.35% ~= 0.1%

Net return from Vanguard: 2.26% - 0.1% = 2.16% > = Fidelity return

I suspect other calculations will turn out similar results, but you
should work the numbers yourself. What matters is your net returns
after taxes, and not what you pay in taxes (AMT or other).

--
Mark Freeland
nNeEwTs[at]sonic.net

On Vanguard's site in the Holdings section for each Tax Exempt bond fund
they provide an AMT percentage. For the funds that I looked at this number
ranged from 4.5% to 18.3%. Does this refer to the amount of yield that
would apply to the AMT calculation? I'm reading this to mean that a higher
number would put me at greater risk for having to pay the AMT if I invest in
a tax exempt fund.