Last year, a Boston-area high-tech company saw its stock plunge from a record high of $58.75 on January 20, to a low of $1.13 exactly 11 months later in November. One employee, who chose to remain anonymous for this article, exercised 1,000 options at $10 a share when the stock reached its peak. With April 16 nipping at her heels, she still owns the shares. Imagine her terror upon learning that the spread of $48.75 multiplied by the 1,000 shares - a total of $48,750 - is subject to a parallel tax system called the alternative minimum tax, or AMT, at a rate of up to 28 percent. Even though her stock currently is worth just $1,130, the resulting tax owed on the spread is $13,650. Less and less alternative Created in 1969, AMT was designed to prevent the very wealthy from dodging taxes through shelters and deductions. Taxpayers are required to calculate both their regular tax and what they would owe under the alternative system - then pay Uncle Sam the higher of the two figures. In effect, taxpayers are simply adding back some tax deductions and income exclusions to regular taxable income to arrive at the alternative minimum taxable income. However, because the AMT was never indexed to inflation, an increasing number of regular middle- and upper-middle-income folks find themselves owing the convoluted tax. "When the Nixon Treasury put this in place, the argument was that everybody should pay something. There were a few hundred people making a million dollars' gross income that due to loopholes paid no taxes," said Professor Bill Raabe, who has written several books on taxes and specializes in taxation at Samford University in Birmingham, Ala. "If you think of it that way, it should exist. But it should be a tax for a very small number of people to pay." But now, he said, "the tax is doing something that it wasn't designed to do....Something's wrong." The AMT is assessed at 26 to 28 percent of income after a certain exemption and allowing for very few deductions, which is how it's supposed to nab the tax-dodging millionaires. Since personal exemptions are not allowed, don't be blind-sided by the higher tax yourself - even if, for example, you and your spouse support six children on a combined salary of $75,000. Though hardly rich, by taking eight personal and dependent deductions you would trigger the alternative tax. "People who were never intended to be subject to the AMT are being caught by it," said David Maloney, a professor of commerce at the University of Virginia. "It's not just the very, very wealthy." Although most folks have never heard of the alternative minimum tax, by the time they do, it will be too late. By 2010, nearly 30 percent of all taxpayers making between $75,000 and $100,000 a year (about 1.7 million people) will be subject to the AMT if it is not changed, according to a Treasury Department study released last year. That's up from just 14,000 filers in 1998. Sam Serio, a regional media relations specialist for the IRS in the District of Columbia, Maryland, and Northern Virginia, says the key problem boils down to one thing. "Basically it's the indexing: whether Congress chooses to index the AMT" to inflation, he said. "Otherwise, more and more people will be affected by it and more people have to do their taxes twice" in order to figure out what they owe. "I sure wish the computations of the AMT were simpler," he added. Tax comparison: AMT versus regular taxes AMT computation Regular tax computation Adjusted gross income Plus: AMT adjustments and preferences Less: AMT itemized deductions Adjusted gross income Less: personal and dependency exemptions Less: greater of total itemized deductions, or standard deduction AMT income Less: AMT exemption Taxable income Multiplied by: regular tax rate AMT base Multiplied by: AMT tax rate Regular tax liability before credits Plus: actual AMT Less: nonrefundable credits Less: refundable credits Plus: other taxes Actual AMT Total tax To calculate whether you owe alternative minimum tax, use IRS Form 6251. To get a quick sense of your AMT liability, compare the results of the first and second columns above, and pay whichever amount is higher. Source: Internal Revenue Service. What triggers the AMT? Unfortunately, there's no telling for sure what will trigger the AMT for any given taxpayer. A combination of any number of factors might set it off. If you have any doubt, it's advisable to fill out IRS Form 6251 along with your regular taxes, so you can see which of the two is higher (and therefore the one you owe). Here is a list of items, or preferences, that might cause liability under the alternative minimum tax; it is not meant to be a complete list. Exemptions. The more exemptions you claim, the more likely it is you'll have AMT liability. Standard deduction. Although the AMT usually hits higher-income folks, this widely used deduction can contribute to AMT liability. State and local taxes. If your state or local taxes are high, you're more likely to be subject to the AMT. Medical expenses. If you claim an itemized deduction for medical expenses, part or all of it will be disallowed when you calculate the AMT. Miscellaneous itemized deductions. If you claim a large number of certain itemized deductions (such as unreimbursed employee expenses, tax preparation fees, etc.), you could end up paying the AMT. Various credits. The more credits you claim, the more likely it is you'll get hit with the alternative tax. Incentive stock options and long-term capital gains. As we saw above, exercising a large ISO is practically guaranteed to stick you with the AMT. A large capital gain reduces or eliminates the AMT exemption amount, which is meant to protect low-income earners from the alternative tax. (See the story titled, "Tax Implications of Stock Options" in the series Understanding Your Options.) Interest on second mortgages. If you borrowed against your home for some purpose other than expenses related to the home, the interest deduction won't be allowed under AMT. Tax-exempt interest. Interest otherwise exempt from the regular income tax might not be for the AMT. Tax shelters. The AMT provides reduced tax benefits for investments in certain types of partnership or limited liability company arrangements involving activities such as drilling for gas or oil (source: Fairmark Press). While there may not be any dependency or personal exemptions under the AMT, you don't have to pay AMT if you meet any of the following exemptions. $45,000 for married couples filing jointly with phase-out beginning when AMT income is over $150,000. $33,750 for single people, or heads of households, with phase-out beginning when AMT income is over $112,500. $22,500 for married couples filing separately with phase-out beginning when AMT income is over $75,000. A tax cut that might increase your taxes Don't expect things to get less complicated anytime soon. As President Bush's proposed tax cut is making its rounds on Capitol Hill this month, the complex 30-year-old AMT is coming under increasingly heavy fire by taxpayers and lawmakers alike. But due to the GOP's determination to push through their cut, combined with the estimated $200-$300 billion over 10 years it would take to fix the outdated AMT, it is unlikely that it will soon undergo the reform experts agree it so badly needs. Although the interests of the wealthy are not exactly anathema to Republicans (nor to Democrats, for that matter), the GOP has been paying little attention to this parallel tax system as it tries to put its massive tax cut on a fast track through Congress. "The changes that are being discussed relate to the regular tax," said Maloney. "If Congress goes forward and enacts Bush's plan, the regular taxes will go down but the AMT will not. So as a result, more people than ever before will be subject to the AMT. It would take away the advantage of the cut people would receive. That's an ironic twist." In principle, most experts agree there's nothing essentially wrong with the AMT, it just badly needs to be updated. "There's a lot of confusion about AMT," said Serio in his Baltimore, Md., IRS office. "Some people think it's an add-on tax and it's certainly not. Some think they'll be paying rates of 31 percent, 36 percent or the top rate of 39.6 percent. But it's not putting you in some huge tax bracket - it's Congress's way of saying you're at least going to pay between 26 and 28 percent, regardless of what your preferences are." When looked at that way, there is a case to be made for keeping the AMT. To echo a sentiment about another federal program, experts subscribe to a "mend it, don't end it" philosophy: keep the AMT, peg it to inflation. In the meantime, if you suspect you might be subject to the alternative minimum tax, you're going to have to calculate both sets of taxes. About that lamentable fact of life, Serio quipped, "I can say thank God for computer software." - Brian Braiker, Salary.com contributor