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Navigating the new tax code

Navigating the new tax code

After much campaigning and debate, a new tax bill was signed into law effective January 1, 2018. Many advisors and their clients are experiencing these changes first hand as tax season for 2018 returns is upon us. While individual tax rates remained largely unchanged, some notable changes include:

  • Tax-exempt advance refundings were eliminated
  • Individual Alternative Minimum Tax (AMT) thresholds increased
  • Deductible State and local taxes (SALT) and mortgage interest received new limits
  • Corporate tax rates moved to 21%; corporate AMT was eliminated



Explaining tax-equivalent yield

Explaining tax-equivalent yield

Tax-equivalent yield provides an apples-to-apples comparison of the after-tax benefits of a taxable versus a tax-exempt bond. This simple calculation shows the return that would be required on a taxable investment to equal the return of a municipal bond or other tax-exempt investment.

For example, the 3% yield of a tax-free bond at a 24% tax rate would yield the same return of a taxable bond, such as a corporate bond, of 3.95%.

Tax-equivalent yield guide (PDF)
Tax-free yield ÷ (1 – tax rate) = Tax equivalent yield

Attractive Yield On a Tax-Equivalent Basis¹

Source: Morningstar Direct and Moody’s.

¹ Yield for Treasuries, Bloomberg Barclays Agg, Corporate Bonds and Municipal Bonds represent the monthly yield as of 12/31/2018. The tax-equivalent yield assumes a tax rate of 40.8%.




National vs. state-specific considerations

National vs. state-specific considerations

There are many state-specific municipal bond funds designed to provide residents of a given state with double tax free income (i.e. income that is free from both Federal and State taxes). While on the surface, this seems like a great idea, bonds within these jurisdictions can frequently trade at less attractive income levels (tighter spreads) compared to those of states that either have no state income taxes or low income taxes. Advisors and clients that are willing to broaden their investment horizons may be able to pick up additional income, along with improved geographic diversification benefits, while still minimizing their overall tax bill.

Why invest in a national vs. state-specific municipal bond?

BMO Intermediate Tax-Free Fund Class I (MIITX) performance and expenses as of 12/31/2018

QTD YTD 1 yr 3 yr 5 yr 10 yr Since 12/27/2010 Expenses. (%)
1.18 1.11 1.11 2.15 3.37 4.66 4.32 0.33 gross
0.33 net

Performance data quoted represents past performance and past performance is not a guarantee of future results. Investment returns and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Mutual fund performance changes over time and current performance may be lower or higher than what is stated. To receive the most recent month-end performance, call 1-800-236-3863. Returns quoted are pre-tax. Investor should consider his or her current and anticipated investment horizon and income tax bracket when making an investment decision as the illustration above does not reflect these factors. For more information about performance, please contact your investment professional. Total returns for periods of less than one year are cumulative.

Hypothetical Tax Equivalent Yields by Income Level for California Investors²

Hypothetical Tax Equivalent Yields by Income Level for Minnesota Investors³

Hypothetical Tax Equivalent Yields by Income Level for New York Investors⁴

Sources: Morningstar Direct and BMO Global Asset Management as of 12/31/2018. All yield info uses 30-day SEC yield.

All data for the BMO Intermediate Tax-Free Fund represents the Institutional share class.

² All statutory and effective tax rates, tax amounts, and tax equivalent yields are based on a married couple filing jointly that reside in the state of California. No write offs, exemptions, or dependents are assumed. Analysis includes Federal and State taxes only, and does not include Alternative Minimum Tax (AMT), local or city taxes. Data provided assumes effective net investment income tax (statutory rate of 3.8%) which begins at income amounts over $250K. BMO Intermediate Tax-Free Fund yield assumes that 0% of income generated was from California bonds. Muni California Intermediate Category Avg Yield assumes that 100% of income generated was from California bonds.

³ All statutory and effective tax rates, tax amounts, and tax equivalent yields are based on a married couple filing jointly that reside in the state of Minnesota. No write offs, exemptions, or dependents are assumed. Analysis includes Federal and State taxes only, and does not include Alternative Minimum Tax (AMT), local or city taxes. Data provided assumes effective net investment income tax (statutory rate of 3.8%) which begins at income amounts over $250K. BMO Intermediate Tax-Free Fund yield assumes that 0% of income generated was from Minnesota bonds. Muni Minnesota Intermediate Category Avg Yield assumes that 100% of income generated was from California bonds.

⁴ All statutory and effective tax rates, tax amounts, and tax equivalent yields are based on a married couple filing jointly that reside in the state of New York. No write offs, exemptions, or dependents are assumed. Analysis includes Federal and State taxes only, and does not include Alternative Minimum Tax (AMT), local or city taxes. Data provided assumes effective net investment income tax (statutory rate of 3.8%) which begins at income amounts over $250K. BMO Intermediate Tax-Free Fund yield assumes that 0% of income generated was from New York bonds. Muni New York Intermediate Category Avg Yield assumes that 100% of income generated was from California bonds.




Engineered for tax-efficient income

Engineered for tax-efficient income

BMO’s suite of tax-free funds seeks to provide a diversified source of income exempt from federal income tax. The driving philosophy for our funds is income plus inefficiencies plus consistency will equal outperformance over time.

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Please note that this information is not intended to be individual legal or tax advice. You should not rely on it as legal or tax advice. Please discuss your individual legal or tax situation with your independent legal and tax advisors.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. All of these factors can subject the funds to increased loss of principal.

BMO Short Tax-Free Fund seeks To provide current income exempt from federal income tax consistent with preservation of capital.

BMO Intermediate Tax-Free Fund seeks to provide a high level of current income exempt from federal income tax consistent with preservation of capital. The fund invests at least 80% of its assets in municipal securities, the income from which is exempt from federal income tax (including the federal alternative minimum tax (AMT). It normally maintains an average dollar-weighted effective maturity of three to ten years. Interest income from Tax-Free Fund investments may still be subject to the federal alternative minimum tax (AMT) for individuals and corporations, and state or local taxes.

BMO Ultra Short Tax-Free Fund seeks to provide current income exempt from federal income tax consistent with preservation of capital.

Muni California Intermediate Fund Category consists of funds that invest at least 80% of assets in California municipal debt. Because the income from these bonds is generally free from federal taxes and California state taxes, these portfolios are most appealing to residents of California. These portfolios have durations of 4.5 to 7.0 years (or, if duration is unavailable, average maturities of five to 12 years).

Muni Minnesota Category consists of funds that invest at least 80% of assets in Minnesota municipal debt and can include long-, intermediate-, and short-duration portfolios. Because the income from these bonds is generally free from federal taxes and Minnesota state taxes, these portfolios are most appealing to residents of Minnesota.

Muni New York Intermediate Category consists of funds that invest at least 80% of assets in New York municipal debt. Because the income from these bonds is generally free from federal taxes and New York state taxes, these portfolios are most appealing to residents of New York. These portfolios have durations of 4.5 to 7.0 years (or, if duration is unavailable, average maturities of five to 12 years).

Interest income from Tax-Free Fund investments may still be subject to the federal alternative minimum tax (AMT) for individuals and corporations, and state or local taxes.

Diversification does not ensure a profit or guarantee against loss.