Recommended strategy: Steer clients into new AMT-free funds
Strategy: Have clients look into new mutual funds designed as "AMT-free." In a twist from previously offered tax-exempt mutual funds, these new financial products don't invest in bonds that could cause AMT complications.
But the new AMT-free funds aren't for everyone. Some investors may come out ahead by buying other bond funds, even if they end up getting hit by the AMT! First, here's a brief recap: You have to run AMT calculations side-by-side with regular income tax calculations. The AMT starting point is an individual's taxable income for the year. Next, add in certain "tax preference items" and other technical adjustments. Then, subtract a special exemption amount based on the individual's tax return filing status (see chart).
Finally, apply the AMT rate to the remainder and compare it to the taxpayer's regular income tax liability. In effect, the client must pay the higher of the two. The AMT rate is 26% for the first $175,000 of AMT income; 28% above that.
What are the key tax-preference items and adjustments? The list is long (see box at left). Example: One of the potential traps facing clients is that interest from private-activity bonds (PABs) must be added to AMT income. Those include municipal bonds used to fund private activities like sports stadiums. Such an add-on could be enough to trigger the AMT. But clients may be able to sidestep this trap by investing in AMT-free funds.
New developments: Some heavy hitters on Wall Street are advertising funds that invest in short-term obligations while barring investments in PABs. Other funds don't make a big deal about avoiding AMT liability, at least not yet. Instruct your clients to check the fund's prospectus or have them call the fund company to determine potential tax exposure.
Here's the best course of action for clients who have been hit by the AMT in recent years or face added exposure this year:
1. Make an estimate now to determine if a client has to pay the AMT for 2007. For a quick look, you can use the IRS' "AMT Assistant ". (The 2007 version isn't available yet.) But we recommend printing out a copy of Form 6251, Alternative Minimum Tax—Individuals, and crunching all the numbers. Find the form at www.irs.gov/pub/irs-pdf/f6251.pdf . If your client appears to have dodged the AMT this year, the coast is clear. If not …
2. Estimate the client's after-tax return if he or she invests in AMT-free funds instead of those with PABs. PABs generally offer a better rate of return than other munis, so the client still could come out ahead by purchasing funds investing in such bonds. Note: In any event, a client must pay state income tax on munis or muni-bond funds if the bonds have been issued out-of-state.
Where can clients find AMT-free funds? Some of the major players offering AMT-free funds are:Fidelity Investments 
Putnam Investments 
Oppenheimer Funds .
Tip: Advise clients to stick with reputable funds as opposed to fly-by-night operations offering unrealistic returns.
What items will trigger the AMT?
Some of the most common tax preferences and adjustments required for the AMT include:Accelerated depreciation of real estate and certain other property.
The "bargain element" of incentive stock options.
Losses from passive-activity investments.
Certain itemized deductions (state and local income taxes, real estate taxes, medical expenses not greater than 10% of AGI).
Miscellaneous deductions in excess of 2% of AGI.
Home-equity mortgage interest, if such proceeds are not used to improve the residence.
Interest on private-activity bonds.
AMT needs another 'fix'
Congress has "patched" the AMT the last few years by bumping up the exemption amounts. Although the new tax legislation enacted in May did not resolve the matter, the conventional wisdom in Washington is that another quick fix will take place this year. Otherwise, the amounts will revert to pre-2001 levels.
Here are the exemption amounts for the past two years and the amounts allowed for 2007 under current law.
Reprinted with permission from The Tax Strategist, July 2007. For continuing advice on this and numerous other tax strategies, go to www.TheTaxStrategist.net . Receive 2 FREE Bonus Reports and a 40% discount on The Tax Strategist when you use Promo Code WN0013.