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No Cliff For Old Munis - Thursday, 01/03/2013

In the eleventh hour of the first night of 2013, Congress passed legislation which, among tax increases and other items, left the municipal bond coupon tax-free and unscathed. As you undoubtedly know by now, the bill provides for extensions of the Bush era tax cuts and credits and permanently "patches" the Alternative Minimum Tax (AMT) going forward.

Personal income taxes for individuals with income over $400,000 and households over $450,000 will increase; as will taxes on dividends and capital gains for those investors. There will be much more debate to follow as Congress must address the deficit and debt ceiling in the coming months.

The rally in the equity markets and the simultaneous sell-off in Treasuries seem to be an expression of relief from investors who had sought safety in bonds while awaiting the outcome of these deliberations. What needs to occur in my view, however, is a response from business that reflects both relief and confidence in the stimulus. Business may need to see how more revenues will be raised and what programs may be pushed over the cliff before employment increases and GDP can rise.

At this time, tax-free investors can exhale knowing that their tax-free income streams remain preserved as we roll off the second strong performance year in a row; the Barclays Municipal Bond Index returned 6.78% in 2012. With higher taxes coming for many Americans, I believe the tax-free coupon makes munis all the more desirable. 

The Higher the Tax Rate the More Attractive Municipal Bonds Become Chart

Based on proposed 2013 federal tax rates. For illustrative purposes only. Taxable equivalent yield = (tax-deferred interest rate) x (1 / (1-your tax bracket). These numbers are examples only and are not representative of future yields. Actual yields may be lower or higher than the example. Income exempt from regular federal income tax may be subject to U.S. federal alternative minimum tax (AMT) as well as state and local taxes.

The Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year.


 


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