Existing alternative minimum tax (AMT) rules are intended to ensure that Canadians pay their fair share in tax by preventing certain individuals and trusts from claiming exemptions, deductions, and tax credits that would generally be available under ordinary income tax rules. Recent changes to these rules, introduced in Federal Budget 2023, would result in certain high-income taxpayers paying more taxes, but fewer middle-income taxpayers being subject to the regime.
Taxpayers that could be subject to the AMT should prepare for the new rules and talk to their advisors about potential steps to reduce AMT or use expiring AMT credits. These changes will be effective for taxation years that begin after 2023, if enacted.
The Department of Finance released draft legislation on August 4, 2023.
The AMT rules generally apply to certain individuals, estates, and trusts that receive a significant portion of their income as dividends or from capital gains or use deductions or tax credits to significantly reduce their regular tax payable. These taxpayers are required to calculate their federal tax owing under the regular method and under the AMT method and must then pay the higher of the two amounts. The AMT method requires taxpayers to calculate their “AMT base” (i.e., adjusted taxable income less the basic exemption amount, where eligible) before applying the AMT tax rate. For example, AMT could apply where a taxpayer claims the capital gains exemption on the sale/transfer of their small business shares or claims significant deductions from investments such as flow-through shares.
However, if a taxpayer pays the AMT for a specific year, they can carry forward the difference between the AMT they paid and their regular tax as a credit for up to seven years. As such, AMT paid can offset future taxes owing under the regular system, but any unused amount after that seven-year period is permanently lost.
Provincial AMT may also apply and is generally calculated as a percentage of the federal AMT amount.
Under the proposed changes, the AMT rate increases to 20.5% (from 15%) so that taxpayers subject to AMT pay more taxes. In addition, the basic exemption amount available to individuals and certain trusts increases to $173,000 (from $40,000) so less middle-income taxpayers will be subject to the tax. The new exemption amount is based on the start of the fourth federal tax bracket in the 2024 tax year.
Other changes
The proposed AMT rules also broaden the scope of the AMT to:
Considerations for trusts
In draft legislation released on August 4, 2023, Finance proposes to exempt additional types of trusts from AMT. Most notably, graduated rate estates would no longer be subject to AMT for tax years beginning after 2023. Employee life and health trusts, mutual fund trusts, and prescribed master trusts would still be exempt from AMT under the new rules.
However, other trusts are more likely to pay AMT under the new rules, even if they don’t have significant income. This is because the basic exemption isn’t available to trusts (except for qualified disability trusts under the proposed rules and graduated rate estates under the current rules). Therefore, many trusts won’t have this exemption amount to offset the broader AMT base.
Let’s consider how changes to the AMT could affect two different taxpayers. In these examples, we make certain assumptions for illustrative purposes. For example, we assume that the tax deductions and credits for 2024 are equal to the 2023 amounts (i.e., not adjusted for indexation) and the AMT basic exemption amount is approximately $173,000.
Ms. Y is a BC resident whose only income in 2024 is a capital gain of $2M on the sale of marketable securities. Ms. Y applies unused capital losses of $1.8 million from prior years against the gain.
Under the proposed AMT rules, Ms. Y would pay about $252,000 in total taxes for 2024 (instead of approximately $22,000 under the existing rules). The taxes owing under the proposed rules includes about $172,000 in federal AMT and $58,000 in BC AMT (up from about $450 and $150 respectively) that would be available for carry forward to reduce any regular taxes owing for up to seven years.
Ms. Y would owe significantly more taxes under the proposed AMT rules because her AMT base would be higher. When calculating the AMT base under the proposed rules, Ms. Y would have to include 100% of the capital gain (up from 80%) and would only be able to deduct 50% of the capital losses applied (down from 80%). Additionally, Ms. Y would apply an AMT rate of 20.5% (instead of 15%). BC AMT would also increase significantly, as it’s based on a percentage of federal AMT.
Mr. X is a BC resident and realizes a capital gain of $300,000 in 2024 on the disposition of shares in a holding corporation. The disposition doesn’t qualify for the lifetime capital gains exemption and Mr. X has no unused capital losses from prior years. Other than an RRSP deduction of $50,000, Mr. X has no other income or deductions in 2024.
Under the proposed AMT rules, Mr. X would pay about $21,000 in total taxes for 2024 (instead of approximately $28,000 under the existing rules, which includes $7,000 in federal and BC AMT in excess of regular taxes). Mr. X would pay no AMT under the proposed new rules because the higher exemption amount (i.e., $173,000 instead of $40,000) would offset the impact of having to include 100% of the capital gain (up from 80%) in the AMT base.
The proposed rules are complex and there may be steps you can take to reduce AMT or utilize expiring AMT credits. Contact your local advisor or reach out to us here to learn more about the proposed changes to AMT and how you can plan accordingly.
Disclaimer
The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.
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