The AMT truly functions as an "alternative" tax system. It has its own set of rates and rules for deductions, which are more restrictive than the regular rules. It operates in parallel with the regular income tax system in that if you're already paying at least as much under the "regular" income tax as you would under AMT, you don't have to pay it. But if your regular tax falls below this minimum, you have to make up the difference by paying the alternative minimum tax.

AMT Red Flags
Certain circumstances and tax items are likely to trigger the AMT:

• If your gross income is above $100,000.
• If you have large numbers of personal exemptions.
• If you have significant itemized deductions for state and local taxes, home equity loan interest, deductible medical expenses, or other miscellaneous deductions.
• If you exercised incentive stock options (ISOs) during the year.
• If you had a large capital gain.
• If you own a business, rental properties, partnership interests, or S corporation stock.

AMT can be triggered by a number of different variables. Although those with higher incomes are more susceptible to the tax, many other factors such as the amount of your exemptions or deductions can also prompt the tax. Even commonplace items such as a deduction for state income tax or interest on a second mortgage can set off the AMT. To find out if you are subject to the AMT, fill out the worksheets provided with the instructions to Form 1040 or complete Form 6251, Alternative Minimum Tax -- Individuals.

AMT rates start at 26%, rising to 28% at higher income levels. This compares with regular federal tax rates, which start at 10% and step up to 35%. Although the AMT rates may appear to cap out at a lower rate than regular taxes, the AMT calculation allows significantly fewer deductions, making for a potentially bigger bottom-line tax bite. Unlike regular taxes, you cannot claim exemptions for yourself or other dependents, nor may you claim the standard deduction. You also cannot deduct state and local tax, property tax, and a number of other itemized deductions, including your home-equity loan interest, if the loan proceeds are not used for home improvements. Accordingly, the more exemptions and deductions you normally claim, the more likely it is that you'll have an AMT liability.

On the positive side, AMT does allow you to apply a special AMT exemption -- $62,550 for joint filers and $42,500 for singles in 2006 -- designed to prevent the AMT from applying to taxpayers with modest incomes. This exemption is reduced by 25 cents for each dollar of AMT taxable income above $112,500 for singles ($150,000 for couples). There's also an "AMT credit" that allows you to claim a credit on your tax return in future years for some of the extra taxes you paid under the AMT. However, you can only use the AMT credit in a year when you're not paying the AMT. To apply for the credit, you'll need to fill in yet another form, Form 8801, to see if you are eligible.

If any of the above apply to you, you should complete the AMT worksheet when preparing your taxes. If you don't, rest assured that the IRS will. And if they find that you owe AMT, they'll add penalties and interest. Worse yet, not paying your AMT liability may trigger an IRS audit.