Please note that changes to the Alternative Minimum Tax are expected to become effective in the beginning of 2024, but have not been enacted as of the date of this GGFL tax news release. Drafts of legislative proposals were released on August 4, 2023, but have not received royal assent as of the date of the release of this article. The government’s release of legislation in November 2023 excludes any changes to AMT that were previously expected to be enacted for January 1, 2024.
This article was co-written with Zachary Bronstein.
What is Alternative Minimum Tax (AMT)?
AMT was introduced in 1986 in the Canadian tax system as a supplementary method for computing Canadians’ income tax obligations.
Unbeknownst to most taxpayers, each year Canadians calculate their income tax obligations according to two methods. The first method is the “regular calculation” that most taxpayers are likely familiar with, i.e., the calculation based on your income, deductions, tax credits, and so forth. The second method, representing the lesser known method, is an “alternative calculation” which, put briefly, takes into consideration the tax that would otherwise be payable if no preferential tax deduction (e.g. the capital gains deduction) has been claimed by the taxpayer. Both methods are complex calculations which follow the requirements of the Income Tax Act.
A taxpayer’s income tax obligation for the year is the highest of the two amounts calculated under each method. For most taxpayers, the first method, i.e., regular calculation, will result in the highest tax amount, and no AMT will be payable. However, if the taxpayer claimed a tax benefit during the year, it may be possible that this second method, i.e. alternative calculation, will result in the highest amount of tax owing, in which case the difference between the amount calculated under the first method and the second method is what is referred to as the taxpayer’s AMT payable for the year.
Any AMT that is payable in a given year is considered a transitional “tax paid in advance” that may be refundable in future years. If sufficient income is earned over the next 7 years, it is possible to recover the AMT paid if enough tax is otherwise payable by the individual, i.e., in future years if the first method exceeds the second method. Unfortunately, if no sufficient income is earned, the AMT will become a permanent tax, and the possibility of recovering the AMT paid will be lost. Planning options can be considered to recover AMT in future years and avoid permanent loss, for example, triggering capital gains on investments.
What situations could trigger AMT?
Some examples of the most common situations when Canadians are subject to AMT are the following:
- Sale of an investment, a principal residence, or shares of a private corporation on which a capital gain exemption is claimed;
- A loss is incurred on a rental property;
- A federal political credit, an investment tax credit, or a federal dividend tax credit is claimed.
Does AMT apply to all Canadian taxpayers?
No, some taxpayers are exempt. For example, AMT does not apply to individuals who have died during the year, or to some trusts including graduated rate estates (i.e., an estate that is a testamentary trust for the first 36 months after the date of death), registered pension plans, registered retirement savings plans (RRSP) and employee profit-sharing plans. Care must be given to determine if your situation meets an exemption.
What are the proposed changes?
In the 2023 Budget, the federal government proposed changes to Canada’s alternative minimum tax calculation to address its concern that too many high-income individuals pay little or no income tax resulting from the benefit of certain tax incentives (e.g., the capital gain exemption).
The proposed changes intend to introduce alterations to how the AMT is calculated under the second method, including, for example, an increase to the inclusion rate of capital gains (from 80% to 100%), an increase to the AMT tax rate (from 15% to 20.5%), a decrease to the inclusion rate for business investment losses (from 80% to 50%), and an increase to the capital gains inclusion rates on donations. Those changes increase the complexity of the AMT calculation and in many cases will broaden its application. As a result of the changes, we expect that more Canadians will be affected by AMT if the new rules for computing AMT under the second method are enacted.
However, it is difficult to determine if those proposed changes will actually achieve the purported goals of the government. Moreover, the changes may have significant adverse effects on the revenue stream for many charities that rely on donations from taxpayers.
Can the proposed changes impact you going forward?
Even if you are not impacted right now, you may be impacted if (list non-exhaustive):
- You expect to claim a capital gains exemption in 2024 or onwards;
- You expect to transfer personal assets with unrealized capital gains to a corporation;
- You expect to donate capital property, such as publicly listed securities;
- Your trust pays interest expenses to earn income from property;
- You have a significant capital gain in 2024 or onwards.
Please contact your GGFL advisor if you would like to discuss how those proposed changes may apply to you and impact your tax planning going forward, as well as explore what transactions should be expedited for execution by December 31, 2023, before the changes become effective.