Important: Though most people don't have to pay any tax under this law, it appears to be necessary to file Form 6251 if you exercise any stock options, just to prove that you don't owe extra tax. So read this stuff. Alternative Minimum Tax is aimed at people who have a large dollar volume of capital gains, accelerated depreciation, option exercises, and intangible drilling costs (I'm not making this up).
Here's the theory behind AMT. Certain types of income get special tax preference, for reasons which are clearly in the National Interest. This results in some people paying low taxes, which is clearly not in the National Interest. Therefore, the government gives subsidies and takes them back again, which is in the National Interest.
If you have these special types of income, here's roughly what you do. Compute your taxable income, and compute the tax on it. Remember this number. To your taxable income, add back some of the deductions you took: accelerated depreciation, intangible drilling costs, 60% of capital gains, and various itemized deductions. Also, if you exercised any Incentive Stock Options in the year, add the difference between the exercise price and the Fair Market Value when you exercised them (the $4.90 in our example, which you thought you didn't have to pay tax on because the options weren't disqualified). Subtract $30,000 (single person) or $40,000 (joint return). Take 20% of that. If this exceeds your normal tax, this is what you pay; otherwise (the great majority of cases) you merely report it and pay the normal tax. Stock options were included in this calculation under the Tax Equity and Fiscal responsibility Act of 1982. The equity of taxing people on a gain which another part of the law says is not to be realized for at least another year (and yet another says can't be realized without going to jail) is self-evident, so I won't explain it. What makes it especially equitable is that while a passive investor pays 20% on his gains, an entrepreneur is allowed to pay up to 40% (plus Uncle Deukmejian's cut). Comments in an earlier edition about rates going up to 52% were wrong, based on an uncritical acceptance of an expert's opinion.
This cloud, too, has a silver lining: if you're paying AMT, then the effective tax rate on any additional ordinary income is down to 20% until you get so much that you're out of AMT land again. This can be significant if you're liquidating assets to get enough money to pay AMT. If you need to understand this in more detail, stop by sometime when you have an extra hour or two, and I'll be glad to give you a quick outline of the situation.
Editor: John Walker