Upcoming changes to the alternative minimum tax (AMT) system, set to apply as of Jan. 1, 2024, could impact high-income earners, but also Canadians who have once-in-a-lifetime gain on the sale of a business or a vacation property. And it could have a profound impact on large charitable donations, which are often made via a gift of appreciated securities.
To better understand who might be affected, let’s review the AMT system with a focus on what’s changing.
The AMT system imposes a minimum level of tax on taxpayers who claim certain tax deductions, exemptions or credits to reduce the tax they owe to very low levels. It is a parallel tax calculation that allows fewer deductions, exemptions and credits than under the regular income tax calculation. If the amount of tax calculated under the AMT system is more than the amount of tax owing under the regular tax system, the difference owing is payable as AMT for the year.
We already have an AMT system, which was introduced in 1986, but barely anybody knows about it because it affects very few people. If you (or your tax preparer) use tax software to prepare your return, you may not realize it, but this parallel tax calculation is being done in the background by the software, which in most cases will show that no AMT is owing.]
In this year’s federal budget, the government announced that “to better target the AMT to high-income individuals,” several changes would be made to the rules, beginning in 2024. The government estimated the changes to the AMT rules would generate $3 billion in revenues over the five-year period starting in 2024.
Under the regular tax calculation, taxable income is calculated using deductions, exemptions and credits that are likely familiar to you. Under the AMT system, taxable income is recalculated using only deductions, exemptions and credits that are permitted for AMT purposes, which is called “adjusted taxable income.”
The current AMT rules apply a flat 15-per-cent tax rate to this adjusted taxable income. For 2024, the AMT rate will increase to 20.5 per cent. To ensure that lower-income taxpayers aren’t caught by the AMT, there is an AMT exemption that is deducted from adjusted taxable income. The exemption is currently $40,000, but will rise to approximately $173,000 in 2024.
Because of this increased exemption, very few Canadians will pay AMT under the 2024 rules, and even high-income individuals won’t pay any AMT if their only source of income is fully taxable employment, professional or business income.
Currently, most common deductions are permitted in calculating the adjusted taxable income for AMT. Starting in 2024, the AMT base will be broadened by disallowing 50 per cent of certain deductions, including: employment expenses (other than those incurred to earn commission income), moving expenses, child-care expenses, interest and carrying charges incurred to earn income from property, limited partnership losses of other years and non-capital loss carryovers.
In addition, starting in 2024, only 50 per cent of the non-refundable tax credits, including the donation tax credit, will be allowed when calculating the AMT. A notable exception to this is the dividend tax credit, which is already disallowed entirely for AMT purposes. (The “gross-up” of taxable dividends is also ignored when calculating adjusted taxable income.)
One of the most significant changes to the revised AMT concerns capital gains. Under the regular tax system, only 50 per cent of capital gains are included in income, but 80 per cent of a capital gain is included when calculating adjusted taxable income under current AMT rules. Starting in 2024, 100 per cent of capital gains will be included in adjusted taxable income. In addition, only 50 per cent of capital losses carried forward from prior years will be deductible.
The result of this change means that high amounts of capital gains realized in a single year may give rise to an AMT for individuals who pay tax at the top federal rate of 33 per cent, since the capital gains tax rate under the regular calculation is 16.5 per cent, and the AMT rate in 2024 is 20.5 per cent.
Consider Carly, who sells her vacation property with a fair market value of $500,000 and an adjusted cost base of $100,000, to realize a $400,000 capital gain. Under the regular tax system, 50 per cent of the capital gain, or $200,000, is included in her taxable income. Using graduated tax rates, her estimated 2024 tax would be $43,603.
Under the 2024 AMT calculation, 100 per cent of the capital gains or $400,000 must be included in Carly’s adjusted taxable income. The AMT exemption of $173,000 is deducted, leaving her with adjusted taxable income of $227,000. Applying the 20.5-per-cent tax rate, a minimum tax of $46,535 arises. Since this minimum tax is $2,932 higher than the regular tax of $43,603, her AMT is $2,932.
Another example where AMT could apply next year is when appreciated publicly traded shares are donated to charity. Under the regular tax system, the capital gain is tax free and a donation credit is available. Under the AMT system in 2024, 30 per cent of the gain arising from the donation of shares will be taxable, and the donation tax credit will be limited to 50 per cent.
Finally, if you do end up paying AMT, it can be used to offset tax arising under the regular system during the following seven calendar years. But if the AMT is significant, as it might be on the sale of a private company or large charitable gift, it might be difficult to recoup without some careful planning.
Further details on how the revised AMT will work, along with several more examples, can be found in a new CIBC report: Alternative minimum tax: What’s changing for 2024?