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.
Who pays AMT and how does it work?
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.
How will the AMT change?
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.
The proposed AMT rules also broaden the scope of the AMT to:
- include 100% (from 80%) of capital gains in the AMT base;
- reduce deductions for capital losses and allowable business investment losses to 50% deductible (from 80%);
- include 100% (from 80%) employee stock option benefits in the AMT base;
- include 30% (from 0%) of capital gains on donations of shares or employee stock options of publicly listed securities;
- reduce certain deductions to 50% deductible (from 100%) (e.g., interest or carrying charges to earn property income, certain employment expenses, non-capital loss carryovers); and
- reduce deductions for most non-refundable tax credits to 50% deductible (from 100%) (e.g., basic personal amount, medical expense credit, disability credit, tuition credit).
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.
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.
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.