Recent changes to the alternative minimum tax (AMT) could have implications on your tax obligations and financial strategy.
In 2023, the federal government announced significant changes to the AMT system. Additional modifications were introduced in the 2024 Federal Budget and passed into law on June 20, 2024. The legislative changes to the calculation of minimum taxable income and AMT are effective as of January 1, 2024.
What is the alternative minimum tax?
The federal AMT is a parallel tax calculation for individuals and trusts that allows fewer deductions, exemptions, and tax credits to be deducted than under regular income tax rules. It was introduced in 1986 to ensure that individuals who benefitted from preferential tax treatment for income or tax deductions would always pay a minimum amount of tax.
These new modifications represent the first major changes to the AMT rules since they were first introduced.
This article reviews these recent changes and the impact they may have on many high-income individuals, including those who realize large capital gains, or who have significant tax deductions or charitable donations. While we will focus on the AMT’s impact on individuals, it can also apply to trusts.
For most individuals, AMT is not a concern as their personal tax will be higher than the tax calculated under AMT. But it can impact taxpayers who benefit from preferential tax treatment on certain items, such as how capital gains are taxed, or those who claim large tax deductions or credits.
If you use tax software to prepare your personal return, it will calculate both regular income tax and AMT. For any year, an individual pays AMT or regular federal income tax, whichever is higher.
Where the AMT is more than regular income tax otherwise calculated, the additional tax paid can be carried forward for seven years to offset regular tax to the extent that the regular tax exceeds AMT in the carryforward period. This means that AMT is essentially a prepayment of tax if the individual can recover AMT paid within the seven-year period.
The changes are meant to reduce the number individuals incurring minimum tax due to the higher exemption amount, while also addressing the government's concerns that too many high-income individuals pay little or no income tax in a given year because of certain tax incentives. For some individuals, AMT under these changes will increase substantially.
There are three main components to the changes to AMT, including broadening the AMT base, raising the AMT exemption amount, and increasing the AMT rate, explained in further details below:
1. Broadening the AMT base
There are several AMT changes that broaden the AMT base by further limiting tax preference items. This includes adding new items in the calculation of the AMT base and increasing the inclusion rates of other items:
- The capital gains inclusion rate for AMT purposes has been increased to 100% from 80%, while the inclusion rate for capital loss carryforwards and allowable business investment losses has been decreased to 50% from 80%.
- Including 100% of the benefit associated with employee stock options, which under regular rules are taxed at 50%.
- Adding 30% of capital gains on donations of publicly listed securities, which under regular rules are not subject to any tax.
- Disallowing 50% of various deductions, such as interest and financing expenses incurred to earn property income, deduction for limited partnership losses of other years, non-capital loss carryovers, employment expenses (other than those to earn commission income), moving expenses, and childcare expenses.
- Allowing only 50% of non-refundable tax credits to reduce the AMT (with certain limited exceptions, including allowing a non-refundable tax credit in respect of donations at 80% of the amount allowed for regular tax purposes).
2. Raising the AMT exemption
The former AMT basic exemption was $40,000, available to all individuals, including graduated rate estates but excluding all other trusts. This exemption was increased to the start of the fourth federal tax bracket, which is $173,205 in 2024. This exemption amount will be indexed to inflation each year.
Starting in 2024, graduated rate estates are not subject to minimum tax. Most personal trusts will continue to be subject to minimum tax without the benefit of the basic exemption.
3. Increasing the AMT rate
Lastly, the proposals include an increase in the AMT rate to 20.5% from 15%.
Alternative minimum tax example
In the following example, the taxpayer performed an estate freeze and crystallized capital gains to use the lifetime capital gains exemption (LCGE). In this illustration, $971,190 of their LCGE was claimed in respect of qualifying small business corporation (QSBC) shares. In the same year, they also earned capital gains on their other investments of $350,000 and donated publicly listed securities with a capital gain of $100,000.
Section | Former AMT rules | New AMT rules |
---|---|---|
Regular federal income taxIncome | ||
Taxable capital gain on QSBC shares | 485,595 | 485,595 |
Taxable capital gain (other capital property) | 175,000 | 175,000 |
Taxable capital gain on donated publicly listed shares | - | - |
Total | 660,595 | 660,595 |
Deductions | ||
Capital gains deduction (half of eligible capital gain) | (485,595) | (485,595) |
Taxable income | ||
Gross income | 175,000 | 175,000 |
Part I federal tax (estimated using 2024 federal tax rates) (Assumes basic credits and donation credit) | 5,240 | 5,240 |
AMT calculation for federal purposesAdjusted taxable income | ||
Taxable gross income from above | 175,000 | 175,000 |
Capital gain on QSBC shares x 30% | 291,357 | 291,357 |
Capital gain on other capital property x 30% | 105,000 | |
Capital gain on other capital property x 50% | 175,000 | |
Capital gain on donation of publicly listed shares x 30% | 30,000 | |
Total | 571,357 | 671,357 |
Less: Basic exemption | (40,000) | (173,205) |
Net amount for AMT | 531,357 | 498,152 |
AMT rate | 15% | 20.5% |
Gross minimum amount | 79,704 | 102,121 |
Less: non-refundable credits (includes donation tax credit) x 100% | (31,096) | |
Less: non-refundable credits excluding donation tax credit x 50% | (1,062) | |
Less: non-refundable donation tax credit x 80% | (23,177) | |
AMT payable | 48,608 | 77,882 |
AMT carryforward | ||
AMT from above | 48,608 | 77,882 |
Less: Part I federal tax from above | (5,240) | (5,240) |
AMT carryfoward available | 43,368 | 72,642 |
Under the ordinary tax rules, crystallizing a capital gain that qualifies for the LCGE results in no immediate tax (i.e., 50% of the capital gain is sheltered by 50% of the LCGE of $485,595). The taxable portion of the capital gains realized on the individual’s other investments increases taxable income by $175,000. The capital gain on the donation of publicly listed shares is exempt from capital gains tax and provides a donation tax credit.
In this scenario, the taxpayer has $5,240 of federal income tax payable under the ordinary tax rules. Under the former rules, AMT in this example is $48,608 and the AMT carryforward (the difference between AMT and regular income taxes) is $43,368.
As illustrated under the new AMT rules, the taxpayer's federal income tax liability increases to $77,882. This is a result of the increase in the capital gain inclusion rate for AMT purposes to 50% from 30% on other investments, and to 30% from nil on the gain from the donation of publicly listed securities.
In addition, while the basic exemption increased to $173,205 from $40,000, the AMT rate also increased to 20.5% from 15%. Furthermore, only 50% of the non-refundable tax credits, except for the donation tax credit, will be available to reduce the AMT. Due to these changes, the taxpayer's AMT under the new rules is significantly higher than under the former rules, and there is a larger AMT carryforward amount.
Note that any applicable provincial AMT would increase the individual's total income tax payable for the year.
What about the changes to capital gains inclusion rates?
In the 2024 Federal Budget, the government proposed changes to the capital gains inclusion rate. On June 10, 2024, draft legislation was released to increase the capital gains inclusion rate from one-half to two-thirds effective for transactions on or after June 25, 2024, with individuals being allowed up to $250,000 of capital gains to be taxed at the 50% inclusion rate.
For further information on these changes, see Government confirms changes to capital gains inclusion rate.
With the increased capital gains inclusion rate, there may be fewer situations where AMT arises going forward. Note that the proposed change to the capital gains inclusion rate is not yet law. The illustration that follows and the related commentary show capital gains at a 50% inclusion rate and do not reflect the proposed changes to inclusion rate.
Additional considerations for AMT rules
Depending on the facts, the federal AMT payable under the new rules may be significantly higher than under the current rules, even though the basic exemption will be increased.
These changes to the AMT rules plus the proposed changes to the capital gains inclusion rate make it more important than ever to consult with your tax advisor prior to realizing large capital gains, making large donations, or making significant changes to your tax deductions. The impact that the new AMT rules may have on you is very much dependent on your specific situation. As AMT also applies to most types of personal trusts, it is important for trustees and their advisors to consider the implications of these new measures as well.
Individuals affected by the changes are advised to plan ahead to better ensure they can recover AMT paid in the carryforward period, where possible. Planning to minimize the impact of AMT will be especially important for individuals in retirement who expect low taxable income in the future.
The information in this publication is current as of July 3, 2024.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.