If you ve been socked with a big alternative minimum tax, or AMT, bill in the past, you may be in luck. Thanks to a little-known provision, you could actually get a refund.

Typically, taxpayers are hit with a big AMT bill because they exercised some lucrative incentive stock options (ISOs). Unlike the regular tax rules, the AMT rules tax you on the bargain element when you exercise an ISO. The bargain element is the difference between the fair market value of the ISO shares on the date you exercise the option and the exercise price. The regular tax rules don t tax the bargain element until you actually sell your ISO shares. So your AMT bill can be bigger (sometimes much bigger) than your regular tax bill in a year when you exercise in-the-money ISOs. Naturally, the IRS insists that you pay the larger AMT amount.

A few years ago, lots of folks exercised in-the-money ISOs and wound up paying huge AMT bills for the privilege. If you were one of them, you could get some of that AMT money back. Here's how:

Regular AMT Credits

One way AMT victims are allowed to offset some of their pain is through the AMT credit. The amount of AMT triggered by exercising ISOs generally results in a credit you can use to lower your tax bills in future years. Any unused AMT credit can be carried forward indefinitely.

Under the general rules, however, you can only use as much of the credit as it takes to reduce your regular tax liability to the point where it equals the AMT. So even if you have a big AMT credit, it does absolutely no good in years when you owe the AMT, and it only does a minor amount of good in years when your regular tax bill is just a little larger than your AMT bill (the typical situation). Therefore, under the general rules, you might die before you ever get a substantial break from your AMT credit.

Tapping Into Little-Known Refundable AMT Credits

Fortunately, there s a huge favorable exception to the general AMT credit rules. Under this exception, unused AMT credits that are more than three years old become refundable, which means you can use them to reduce both your regular federal income tax bill and your AMT bill and then collect any leftover credit amount in cash. You can take advantage of the refundable AMT credit rules when you file your 2008 Form 1040.

The refundable AMT credit amount for a particular tax year only includes unused AMT credits that were generated more than three years earlier. These are also referred to as long-term unused AMT credits. So for the 2008 tax year, you can only have a refundable AMT credit if you have unused AMT credits that were generated more than three years earlier --which means in years prior to 2005. (For newer AMT credits, you re stuck with the less-favorable general rules.)

The refundable AMT credit amount for the current year is limited to the greater of:

* 50% of the long-term unused AMT credit amount carried into that year (for 2008, this means the amount of credits generated in pre-2005 years) or

* The amount of refundable AMT credit for the preceding year (for 2008, this means the refundable AMT credit amount, if any, from your 2007 Form 1040).

However, the refundable AMT credit for the current year cannot exceed the long-term unused AMT credit carried into that year. Sound confusing? The following example should clarify how the limitation rule works. Under this simple scenario, the entire long-term unused AMT credit was generated in the same year.

Example: Say you generated a whopping $150,000 AMT credit in 2004 when you exercised some profitable ISOs. For 2008, the entire $150,000 amount counts as a long-term unused AMT credit, since the whole amount was generated before 2005. For 2007, you had no refundable AMT credit -- because your credit was not yet old enough.

Your 2008 refundable AMT credit amount figured under the annual limitation rule is $75,000 (0.50 x $150,000). You can collect the entire $75,000 simply by filing out a Form 8801 (Credit for Prior-Year Minimum Tax) and including it with your 2008 Form 1040. By collect I mean you can use the $75,000 credit to reduce your 2008 federal income tax bill (including any AMT) to as low as zero. Any leftover credit amount will be sent to you in cash.

For 2009, your long-term unused AMT credit amount is the $75,000 left over from 2008. Under the annual limitation rule, the entire $75,000 is refundable (because it equals the 2008 refundable credit amount). So you can collect the entire $75,000 simply by filing your 2009 Form 1040.

When all is said and done, you get to collect the whole $150,000 over two years. Not bad.

Note: Things get more complicated when you have credits that were generated in several different years. However, once the credit from any particular year is over three years old, you can always collect it over a two-year period (if not sooner) under the refundable AMT credit rules.

My advice: Don't miss out on this credit if it s available to you. And if you have significant bucks at stake, consider hiring a tax pro to get the numbers right.