Many of your clients could soon be caught in a tax trap that was designed many years ago to snare fat cats. And, when they are caught, will they become angry with you?

The Alternative Minimum Tax (AMT), originally intended to catch fat cats who escaped taxation with myriad deductions, is soon going to snag cats few would consider fat.

"It's really a terrible thing. It's supposed to be a rich man's tax, but it is catching secretaries and stenographers and all sorts of people it was never designed for," says George Marotta, a certified financial planner with Marotta Asset Management in Charlottesville, Va.

Indeed, a fat cat under the AMT, in some cases, has been defined as someone with an annual income of $33,750 and the head of a household. How could someone with less than $35,000 in annual income be defined as a fat cat? The person in question had a big family with numerous deductions. And the frequency of those with modest incomes being caught in an AMT problem is going to increase dramatically over the next few years.

"In 1990, the AMT financially affected only 132,000 taxpayers. In 2000, it affected an estimated 1.3 million taxpayers, and in 2010, it is projected to affect 17 million taxpayers," declares a report last year by the Joint Economic Committee of the United States House of Representatives. Many of those 17 million people will not be fat cats, but instead upper middle-income people with stock options, investment income, people who do much itemizing or Mormons with large families who claim many deductions. (The $33,000-income case was a Mormon with a large family.)

"This was a poorly designed tax that shows the consequences of incorporating class warfare into the tax code," says Joint Economic Committee Executive Director Chris Frenze. The report noted that the AMT has had unintended consequences, as have previous taxes.

"Like the income tax itself, the AMT was enacted as an attempt to target the rich but has become a tax on parts of the middle class," wrote Kurt Schuler, a senior economist of the committee and author of the report. "If nothing is done to reform the AMT it eventually will become the dominant type of income tax. If Congress could have foreseen in 1969 how the alternative minimum tax would turn out, it is doubtful they would have approved it."

How did it happen that a tax aimed at the super rich is now applied against many middle-class people? There are two primary reasons. First, the alternative minimum tax rate hasn't been indexed fast enough to correct for inflation. And second, when the marginal federal tax rates were cut last year, the move to provide tax relief inadvertently caught many middle-income people in the parallel world of the AMT.

Others who are in danger of being snagged are those who live on investment income, including many retirees. The AMT also often hits people with a lot of 1099 income, because there are very few strategies they can use to avoid it, say financial advisors.

"There's really not a lot you can do. It's a nightmare," says Eleanor Blayney, a partner at Sullivan Bruyette Speros & Blayney in McLean, Va.

The AMT is not a bad dream. Unlike regular income taxes, once the AMT is triggered, fewer exemptions and credits are allowed. The tax was part of the Minimum Income Tax Act of 1969, which was aimed at the few people then with annual incomes of $200,000 or more who had found a way not to pay any income tax. (At the time, Congress estimated less than 200 well-heeled individuals were escaping income taxes by coming up with dubious deductions or loopholes, most of which were closed in the 1986 tax-reform law.)

The AMT was going to cover these high-income taxpayers who skillfully and legally took advantage of a complex tax code. Nevertheless, some 33 years after the first AMT legislation, the law has, once again, illustrated the principle of unintended consequences.

Back in the 1960s, Congress was only aiming at a small number of people, so few cared about this arcane tax. When the AMT began, those with $20,000 a year or less in income were exempted, which included most wage earners in America. The AMT's problems, say joint committee members, are because it isn't indexed and its exemption numbers haven't been moved up fast enough. The result: The exemption today is only $49,000 for married couples and $33,750 for single filers. That, of course, means tens of millions of Americans are at risk of getting torpedoed by the AMT. And tens of millions of others, who don't feel rich, will be treated like fat cats.

Blayney says it "is critically important that those clients in danger of the AMT have intensive sessions with their clients, so at least they know the dangers of this tax." Those who accept stock options in lieu of pay, she said, have sometimes been stuck with an AMT bill that is worth more than the value of the stock.

When employees are given options as compensation or an incentive, these options aren't taxable until they are exercised under the regular income tax system. But, under AMT, the paper gains of the stock are counted as income. When some people last year waited to exercise their options after their stocks dived, many of them were hit by multimillion-dollar AMT bills for stocks that were suddenly worth a fraction of their taxes.

Blayney says, in some cases, options can and should be reversed. And advisors agree that stocks have become such a potential tax menace that they deserve special treatment. "No one who plans to exercise a stock option and sell a stock should do so without consulting a tax planner," says Alan Gotthardt, a certified financial planner with Polstra & Dardaman in Norcross, Ga., who devotes much of his time to AMT planning.

Gotthardt says sometimes the AMT trap can be avoided by deferring preferences and deductions. And sometimes there is nothing that can be done to avoid AMT, but it's always better that the client knows what he or she is facing before it happens, he adds.

Others who are at risk of the AMT include those who perform a lot of independent-contractor work and those living in high-tax states. The latter are often in trouble because they deduct their local and state taxes. Middle-income people, in the $50,000 to $75,000 range and with four personal exemptions also are likely to be hit with the AMT, according to a congressional report. One percent of this income group was paying the tax in 2000, but by the year 2010, it is expected to be 32% of this group.

"The primary reason for this change," says a General Accounting Office (GAO) report, "is that for middle-income taxpayers, personal exemptions are projected to be the largest and most common items to be added back into taxable income under AMT." In most cases, there is lot the taxpayer or advisor can do to avoid, planners say. Blayney concludes that there is only one solution to the problem of the AMT: "Call your congressman."

Apparently lots of calls have been made. A recent check of a congressional database showed at least 10 bills that would change some aspect of the AMT. One of them, SB-616, sponsored by Kay Bailey Hutchison of Texas, would repeal the AMT on individuals and raise exemptions on small businesses. It was in committee as Financial Advisor went to press.

But it is unlikely there will be any short-term solution, warns Frenze of the joint committee. "In the long term, I'm sure this thing will be fixed, but in the next year or so, I don't think a reform will go through," he predicts. Frenze notes there are several bills pending in Congress to reform the controversial AMT. However, he says because the country is fighting a war, AMT-reform legislation is unlikely to pass this year because the government needs all the money it can obtain.

Frenze adds that the loss or reduction of AMT tax money would cost the government tens of billions of dollars over the next decade. "Right now," he says, "I don't see that happening." Indeed, the amount of AMT returns and the revenues generated by those returns are exploding, according to IRS figures. From less than $5 billion in revenue in 1990, the IRS estimates that the revenue the government receives in AMT returns will exceed $45 billion by the end of this decade.

An attempt to phase out the AMT over a seven-year period failed in 1999 when President Clinton vetoed the measure: "By using projected surpluses to provide a risky tax cut, HR-2488 could lead to higher interest rates, thereby undercutting any benefits for most Americans by increasing home mortgage payments, and credit card rates," Clinton wrote in the veto message.

So financial professionals are going to have to live with the AMT at least in the short term. The basic difference, advisors note, between the AMT the regular income tax system is the latter favors high-tax states at the expense of low tax states. The general principle of the regular income tax system, Blayney notes, is that one tries to defer income and accelerate deductions. But with the AMT, she says, tax advisors should recommend the opposite.

Then there is the persistent problem of inflation. "The lack of inflation indexing in AMT causes taxpayers' AMT liabilities to increase faster than their regular tax liabilities," says James R. White, director of tax issues for the General Accounting Office, in a recent statement to Congress. "Real income growth-growth above inflation-will increase both regular and AMT liabilities." And this is a key issue, planners say.

Whenever there is a regular and AMT liability, it is the latter that is always higher, and it is the latter that the taxpayer must pay. And with inflation pushing all these numbers higher, White warns the result is that, over time, more taxpayers will have an AMT liability that exceeds their regular tax liability as long as there is inflation. He notes that, if Congress had adequately corrected for inflation, the number of those affected by the AMT would have stayed constant-about 2.1 million by the year 2010 instead of the projected 17 million.

Compounding the problem of the AMT is the complicated nature of the tax. Figuring it out is expensive. The original tax legislation, for example, was 19 pages of average-size type in the statute book. Still, with explanations and amendments, by 1999 AMT legislation took up 56 pages of small type in one printed version of the Internal Revenue Service Code. Even the people who administer this tax agree it is a very difficult tax to interpret because taxpayers are making twice as many computations.

"AMT requires taxpayers to compute their regular tax liability and then recompute their AMT liability using a different base of income, different exemptions and different tax rates," according to the GAO report. IRS frontline employees consistently "rank AMT as one of the most complex provisions with which they deal," the report said.

That's why the American Bar Association's Section on Taxation, the American Institute of Certified Public Accountants and the Tax Executives Institute don't want the AMT "reformed." They want it abolished. It's clear that something eventually will be done about the AMT-whether it is to abolish this pesky impost that generates so much money for the government, or reform it. In the meantime, the average advisor's most important clients are or will likely be in danger of stepping into the fat-cat trap.