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Wednesday January 9, 12:00 AM
Tax-Free Options for the Future |
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From Standard & Poor's weekly investing newsletter The Outlook
New York lawmaker Charles Rangel says he wants to help the middle class by doing away with the alternative minimum tax [AMT], a part of the tax code so complicated most people can't definitively say how and to whom it applies.
But this much is known. According to the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, the AMT is expected to affect about 32.4 million U.S. taxpayers in 2010, up from a mere 3.6 million in 2006. In 2006, the tax generated $23.9 billion in revenues for government coffers. In 2010, it should bring in $117.4 billion.
Complicated and Poorly Designed
Rangel, the chairman of the U.S. House of Representatives Ways and Means Committee, has introduced legislation that would, among other things, repeal the AMT. To offset the loss of revenue, Rangel has proposed raising taxes in other areas, which would primarily affect those with household incomes above $500,000, according to the Tax Policy Center.
"Rangel's goal is an honorable one," says Dan Loughran, a portfolio manager and the team leader of Oppenheimer Funds' 18 tax-free bond funds. "The AMT is extremely complicated and poorly designed from the start. It is not doing what it was designed to do, which was basically to prevent a small number of people, 150 or so, from paying no taxes at all. But now it affects more people in high-tax states, like New York and New Jersey, and it's creeping down the income bracket."
Loughran expects taxes to rise after the Presidential election, regardless of whether Rangel's bill is successful. He points out that Democrats have control of both House and Senate, and he expects them to maintain that edge post-election; and Democratic candidates for President have ambitious spending plans. John Edwards wants health care for every American [pegged at up to $120 billion by some estimates]. Barack Obama would like to spend $150 billion on developing alternative energy and creating new jobs. The money is more likely to come from an increase in taxes, as opposed to a cutback in spending, Loughran says.
Tax Exempt Times Three
"The easiest thing for Congress to do is to let Bush tax cuts expire in 2010, which would be a de facto tax increase," Loughran says. That is widely expected to happen. And that's when tax-free securities can become an even more valuable part of a diversified portfolio. According to Loughran, people invest in muni bonds for diversification, because they like the lower volatility that comes with a tax-exempt instrument, and because munis provide tax-free income.
Oppenheimer even offers bond funds that are AMT-free, such as the Oppenheimer AMT-Free New York Municipals fund (OPNYX), triple tax-exempt for New York state residents, and the Oppenheimer AMTFree Municipals fund (OPTAX).
Steven Permut, portfolio manager of the American Century High-Yield Municipal fund (ABHYX), agrees tax rates are almost certain to rise no matter who triumphs in the November, 2008, election. "That's going to make munis even more compelling as an investment," he says. "Investment grade munis have a default rate of 0.1% -- practically zero -- and munis have a lower default rate than corporates of similar ratings. What's more, the correlation between the economy and default rates is very weak. Even if the economy goes into recession, default rates will not go up."
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