Until the passage of the 1986 Code, banks and thrifts were able to deduct the cost of carrying tax-exempt municipal bonds. However, the passage of this law resulted in many changes affecting the purchase of tax-exempt securities. Banks, thrift institutions and corporate investors are not allowed the deduction to carry tax-exempt bonds as an investment. The previously existing alternative minimum tax (“AMT”), was modified and book income based AMT was imposed.
Alternative Minimum Tax (AMT)
Although the AMT was designed to assure that taxpayers who realized real economic gains paid taxes on those gains, the interest income from municipal bonds was historically exempt. However, the 1986 Code changed the status of interest income from municipal bonds for both individuals and corporations.
For individuals, the law treats certain municipal bonds as preference items which are subject to the AMT.
- No municipal bond issued prior to August 8, 1986 is subject to AMT.
- Bonds issued after August 8, 1986 are subject to AMT if such bonds are deemed “private activity” bonds. IRBs fall into this category.
There are two provisions in the law that regulate the calculation of AMT for corporations.
- The first provision is identical to that for individuals for bonds issued after August 8, 1986.
- The second provision places a 10% implicit tax on municipal bond interest income, regardless of the date of issuance. Corporations are subject to AMT on all tax-exempt interest income on a formula basis.