Over 20 years ago, Congress passed the Alternative Minimum Tax (AMT) as a way to get the wealthy to pay their fair share of taxes.  The problem is that — because the limits are not adjusted for inflation — the AMT is hitting those who are not necessarily wealthy and are by many definitions middle-class. The AMT tax for 2010  is computed at 26% or 28% for individuals and 20% for corporations on taxable income.

The burden of the alternative minimum tax can definitely be a shock.  Besides having to pay higher taxes, the complexity is mind-numbing.  Keep in mind that the AMT is really a separate tax system.  Thus, when you prepare your taxes, you probably need to pay a higher fee for your tax accountant.

Realizing these issues, the mutual fund industry has taken note.  In fact, over the years, there has been a variety of AMT tax-free offerings.  Now, this does not mean you can avoid calculating your AMT exposure.  But, it can result in a lower tax bill.

Let’s take a look at some of the funds:

Fidelity AMT Tax-Free Money Fund (FIMXX)

As should be no surprise, Fidelity has an assortment of AMT-free funds.  One of the groups is for money market funds.  There is one — the AMT Tax-Free Money Fund (MUTF: FIMXX) — for those who do not live in a state that has income taxes.

Ok, but don’t expect to make much unless you have millions to put to work.  The average annual return for the past 10 years was 1.60%.  Actually, the past year’s payout was only 0.02%.

Fidelity also has versions for different states.  These include the California AMT Tax-Free Money Market Fund (MUTF: FSPXX), the Massachusetts AMT Tax-Free Money Market Fund (MUTF: FMSXX), the New Jersey AMT Tax-Free
Money Market Fund (MUTF: FSJXX) and the New York AMT Tax-Free Money Market Fund (MUTF: FSNXX).

However, be wary.  Muni money market funds are not as secure as traditional money market funds, especially those backed by Treasuries.  So for investors, a better option may be to look a muni bond funds.

Fidelity Tax-Free Bond Fund (FTABX)

Of course, Fidelity also has an offering for AMT-free bonds.  It’s called the Fidelity Tax-Free Bond Fund (MUTF: FTABX), which has $1.8 in assets.

But like many other muni funds, there has been recent volatility.  For example, in the fourth quarter, the fund was down by about 4.40%.  Yet when compared to its peers, it was a good performance.

Until recently, investors had little concern about potential defaults with muni bonds.  But there are certainly reasons now to be concerned.  There are budget crises in many state (just look at the protests in Wisconsin).  Interestingly enough, influential Wall Street analyst Meredith Whitney recently published a report that forecasts widespread defaults.  There was another negative report from Nouriel Roubini, who believes the defaults will come to about $100 billion over the next five years.

Despite all this, the Fidelity fund has weathered major storms over the years.  And this was no fluke.  Essentially, the Fidelity fund has a focus on higher quality issues and those that react better in higher-rate environments.  There is also little leverage in the portfolio.

DWS Intermediate Tax/AMT Free A (SZMAX)

DWS Intermediate Tax/AMT Free Fund (MUTF: SZMAX), which has $1.4 billion in assets, pursues a fairly conservative strategy and has been able to effectively deal with market turbulence.

True, in light of the muni meltdown, it is tempting to ramp up the risk levels.  But if history is any indication, DWS’s managers will likely remain disciplined.

After all, volatility is likely to continue and DWS’s strategy has worked quite well.  The average annual return for the past three years is about 4.76%.

Pioneer AMT-Free Municipal A (PBMFX)

With $838 million in assets, Pioneer AMT-Free Municipal A (MUTF: PBMFX) takes a more aggressive approach to the muni bond market.  This means the credit quality is relatively lower and the maturities longer.

The Pioneer fund has a strong management team (which include David Eurkus and Timothy Pynchon), with decades of experience.  For the past three years, they have produced an average annual return of 4.47%.

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