The 2023 federal budget announced significant changes to the Alternative Minimum Tax (AMT) regime to target high-income individuals better. On August 4, 2023, the Department of Finance released draft legislative proposals to modify the AMT regime, effective for taxation years beginning after 2023. The proposed changes would be the most extensive reforms to the AMT regime since it was introduced in 1986.
Today, we find ourselves grappling with this new set of AMT rules, which have unique nuances and implications for taxpayers. Familiarizing yourself with these changes is essential to making informed financial decisions, so we've compiled the following comprehensive guide to help you understand how it'll affect your tax situation going forward.
Understanding the Alternative Minimum Tax (AMT)
AMT is an alternative method of calculating your taxes payable each year to impose a minimum level of tax for both individuals and trusts. It's applicable in taxation years where you may have relied on certain tax exemptions and deductions to reduce your ordinary taxes payable meaningfully. AMT will be calculated in parallel with ordinary income taxes, and if the calculation under AMT is higher, you'll be required to pay AMT.
The New AMT Rules
Key changes to the AMT rules for taxation years after 2023 are as follows:
- The AMT Rate: AMT currently calculates tax on adjusted taxable income (ATI) at a rate of 15%. This will now increase to 20.5%.
- The AMT Exemption: This exemption is the amount of your ATI on which AMT will not apply.The current exemption is $40,000, increasing to $173,000 in 2024 (indexed annually).
- Capital Gains and Losses: Under the current AMT regime, the inclusion rate for the purposeof computing ATI is 80% for capital gains, capital losses and business investment losses (ascompared to a 50% inclusion rate for computing ordinary taxable income). Under the newrules, the inclusion rate for the purpose of computing ATI will be 100% for capital gains, and 50% for capital losses and business investment losses.
- Deductions: Certain deductions such as employment expenses, moving expenses, childcare expenses, interest and carrying charges incurred to earn income from property and non-capital loss carryovers are 100% deductible under the current AMT rules. The new rules will limit the deduction to 50% for the purpose of computing ATI.
- Non-refundable Credits: Non-refundable tax credits[1] reduce taxes payable but will not generate a refund beyond NIL taxes payable. Except for the dividend tax credit, these credits will be reduced to 50% under the new AMT rules.
- Lifetime Capital Gains Exemption (LCGE): The LCGE shelters up to $971,190 (indexed for 2023) of a capital gain from the disposition of Qualified Small Business Corporation (QSBC) shares or Qualified Farm or Fishing Property from ordinary income tax. Under both the old and new AMT rules, the portion of a gain from the disposition of QSBC shares that is eligible for the LCGE is included in ATI at 30%. The AMT rate and AMT exemption under the new rules have changed, but the income inclusion percentage remains the same. Additionally, any portion of the gain that is not eligible for the LCGE is subject to the new 100% inclusion rate.
- Donation of Publicly Listed Securities: Under the current rules, there is a zero-inclusion rate for capital gains realized on in-kind donations of publicly traded securities. Under the new rules, the inclusion rate will be 30%.
- Employee Stock Options: Stock option benefits are generally included as employment income. If the options qualify, the income inclusion may be reduced to 50% for ordinary taxes payable. The income inclusion under the current AMT rules is 80%, which will increase to 100% under the new AMT rules.
Impact to Trusts
The new AMT rules also extend to trusts. As it was before, the new AMT rules will not apply to certain trusts, such as mutual fund trusts and employee life/health trusts. In addition, the new rules will not apply to graduated-rate estates. Additionally, the new rules will allow qualified disability trusts to apply the basic exemption ($173,000 indexed for 2024) to their AMT calculation; however, no other trusts will have access to the exemption.
The limitation on certain deductions when computing ATI could cause some trusts to be subject to AMT. Generally, a trust that allocates all of its net income for the year to its beneficiaries will have no taxable income for the year, and thus no ordinary income tax payable. If the trust deducted interest incurred to earn income from property when computing its net income under ordinary rules, it has to include 50% of the interest deducted in its ATI and, therefore will be subject to AMT on that amount.
Tax Credit for AMT Previously Paid
AMT paid in a particular tax year may be claimed as a tax credit against ordinary income tax payable in any of the next seven taxation years, but only to the extent that ordinary income tax payable in a particular future tax year exceeds AMT payable for that future tax year. If the taxpayer has limited income in those next seven taxation years, they might not be able to use the AMT tax credit fully.
Effects on the Average Taxpayer and Trust
The new AMT rules appear to better target high-income earners who would otherwise receive preferential tax rates through credits, deductions, and exemptions. However, in many instances, the new AMT rules will negatively affect all taxpayers regardless of income level.
For example, consider if your family relies on the sale of investments or properties as a retirement income. A large capital gain in a single year may trigger AMT under the new rules, and you may not have enough ordinary income tax payable in future years to fully utilize the tax credit for AMT paid in a prior year. This may mean that you could significantly impact your cash flow for retirement.
Additionally, the new rules will negatively impact the popular inter-vivos family trusts, which will suffer from the expanded tax limitations without having access to the increased AMT exemption amount as an offset. This will mean that many trusts will likely pay more tax, not just high-income earners' family trusts.
The Bottom Line
The new AMT rules represent a sizeable change in the Canadian tax landscape, and their effects will be far-reaching. To ensure you're up to date on how these changes will impact your situation, contact your CPA. They'll walk you through if and how these rules will apply to you and ensure you're well-positioned to their implementation.
[1] e.g., the basic personal amount, the spousal amount, the age amount, donations, medical expenses,
etc.
Written by:
Nav Pannu, CPA,
DMCL Chartered Professional Accountants.
This document was written for our quarterly bulletin, Canadian Overview, published by Canadian member-firms of Moore North America.