AMT Muni Funds Are Worth a Look

American taxpayers experienced the full weight of the Tax Cut and Jobs Act on their tax bills for the first time beginning in April 2019. One of the changes that garnered less attention during last year’s reform debate, yet likely had significant implications for millions this year, was the reform package’s treatment of the Alternative Minimum Tax, or AMT. Under the Internal Revenue Code, the AMT is a separate tax calculation that certain high-income earners are required to make when computing their final tax bill. It includes a unique tax-rate structure and eliminates many deductions and credits permitted by the traditional tax calculation, often creating a larger bill for those who qualify for it.

In recent years, more folks found themselves subject to the AMT; prior to 2018, the Tax Policy Center estimated that more than 5 million taxpayers fell into this group. However, 2018’s tax reforms included, among other things, higher amounts for earned income that would be exempt in the AMT calculation and with that, the number of individual filers subject to the AMT was estimated to drop. Moving forward, it was estimated that 200,000 individual taxpayers would be subject to the AMT, and corporations are no longer exposed to AMT liabilities.

For some muni investors, this change creates investment opportunities. That’s because while the tax-free income offered by muni bonds has long been an attractive feature of that market, savvy investors recognize that not all munis escape the AMT calculation. Certain bonds issued to finance airports, sports stadiums, or any other development that falls outside of the strict definitions for government use and function are considered “private-activity bonds” and therefore can be subject to the AMT.

Many municipal strategies, such as Fidelity Tax-Free Bond FTABX and T. Rowe Price Tax-Free Income PRTAX, which have Morningstar Analyst Ratings of Gold, are set up to avoid investing in AMT muni bonds for those investors who want to make certain their municipal-bond interest income is totally free from federal tax obligations.

But Charlie Hill, a veteran portfolio manager on T. Rowe Price’s tax-exempt investment team, recently suggested that by taking this tack, investors could be leaving money and opportunity to diversify their portfolios on the table: “We like AMT bonds for two reasons--the incremental yield pickup that these bonds offer and the increased access to sectors of the muni market that are dominated by AMT bonds.”

Hill explained that bonds issued by the same entity with similar security provisions but different tax implications often offer investors more yield: “For example, bonds issued by the Denver Airport that are subject to AMT will pay roughly 25 basis points more than non-AMT bonds.”

He also noted that several sectors in the muni market, such as ground transportation projects (including public-private partnership toll roads) and industrial revenue/pollution-control revenue projects (including solid waste and paper-facility development), are dominated by bonds subject to the AMT and often trade at even wider spreads. “So, adding AMT bonds to a portfolio allows for additional yield and more investment opportunities.” Hill added, “Moving forward, with fewer individuals and corporations subject to the tax, demand for AMT should increase and spreads should decline.”

That could certainly provide a boost to funds already invested in the space. As investors continue to pile into municipal funds in 2019, the supply of new issuance in the muni-bond market remains muted and credit spreads in traditional muni sectors are tight. Many managers report that opportunities to find deep value can be hard to come by and are more interested than ever in researching AMT offerings.

Several funds in the muni national long Morningstar Category that feature Morningstar Medalist ratings include AMT exposure and have proved worthy options for investors. Those funds include T. Rowe Price Summit Municipal Intermediate PRSMX and T. Rowe Price Summit Municipal Income PRINX, which held 12.5% and 18.3% of AMT exposure as of July 2019, respectively.

Hill argues that bottom-up, value-based research has helped both to solid long-term records. Other Gold-rated national muni funds on the list include Fidelity Intermediate Municipal Income FLTMX and Fidelity Municipal Income FHIGX, which also stack up well versus the competition over the long haul.