The federal budget released on Tuesday did not contain a general tax rate increase for the wealthy, but the government did announce that the capital gains inclusion rate will be going up and it amended the draft alternative minimum tax rules in response to concerns of the charitable sector.
Let’s take a look at each of these changes.
Increase in the inclusion rate
Under the current tax rules, if you dispose of capital property (other than your principal residence) for a profit, only 50 per cent of the capital gain is included in taxable income. The budget proposed to increase the capital gains inclusion rate to two-thirds (66.67 per cent) for corporations and trusts, and to two-thirds on the portion of capital gains realized for the year on or after June 25, 2024, that exceeds $250,000 for individuals.
The $250,000 threshold will apply to capital gains realized by an individual, net of any capital losses either in the current year or carried forward from prior years. Employees who exercise employee stock options and who can currently claim a 50 per cent deduction will now only be entitled to a one-third deduction of the taxable benefit to reflect the new capital gains inclusion rate. They will still, however, be entitled to a 50 per cent deduction of the taxable employment benefit, up to a combined limit of $250,000 for both employee stock options and capital gains annually.
Capital losses carried forward from prior years will continue to be deductible against taxable capital gains in the current year by adjusting their value to reflect the inclusion rate of the capital gains being offset. This effectively means that a capital loss realized at the current 50 per cent allowable rate will be fully available to offset an equivalent capital gain realized after the rate change.
Giving taxpayers 10 weeks’ notice before the new two-thirds inclusion rate kicks in is helpful in terms of tax planning, but it will mean a complex tax reporting system for 2024 since two different inclusion rates will apply.
As a result, the government announced that transitional rules will be introduced that will require taxpayers to separately identify capital gains and losses realized before the June 25, 2024, effective date (period 1), and those realized on or after that date (period 2).
Individuals will therefore be subject to the higher two-thirds inclusion rate on their realized gains arising in period 2 that exceed the $250,000 threshold, except to the extent that those net gains are offset by a net loss incurred in period 1 (or some prior period loss carryforward).
The annual $250,000 threshold for individuals only applies to net gains realized in period 2 and isn’t prorated for 2024.
Considering that capital gains realized from June 25, 2024, onwards in a corporation will be taxable at a two-thirds rate whereas individuals can benefit from a 50 per cent inclusion rate on the first $250,000 of annual gains, some investors may need to consider whether holding investments with the potential for capital gains in a corporation still makes sense.
For everyone else, especially investors with significant accrued capital gains in a non-registered portfolio, it means you’ll need to make some big decisions on whether to crystallize your gains (assuming they’re more than $250,000) at a 50 per cent inclusion rate prior to June 25, or continue to hold onto those winners and face a 66.67 per cent inclusion rate when you ultimately do sell. It may also mean intentionally realizing $250,000 of capital gains annually to take advantage of the lower 50 per cent inclusion rate going forward.
Business owners contemplating a sale, vacation-home owners and investors who own income properties need to consider the broader implications of this pending inclusion rate increase on their longer-term disposition planning.
Alternative Minimum Tax
The Alternative Minimum Tax (AMT) imposes a minimum level of tax on taxpayers who claim certain deductions, exemptions or credits to reduce the tax they owe to very low levels. In last year’s federal budget, the government announced that changes were coming for 2024 “to better target the AMT to high-income individuals.”
Under the AMT, there is a parallel tax calculation that allows fewer deductions, exemptions and credits than under the ordinary income tax calculation. An individual pays the AMT or regular tax, whichever is higher.
In August 2023, the government released draft legislation for the proposed measures, which included broadening the AMT base by further limiting tax preferences (such as exemptions, deductions and credits), increasing the AMT exemption and raising the AMT rate.
The exemption amount is the amount of income below which AMT will not apply. It is available to all individuals and is intended to protect lower- and middle-income individuals from being subject to the AMT.
Under the new AMT rules, the exemption is increasing from $40,000 (2023 and prior years) to the start of the fourth federal tax bracket, which is $173,205 for 2024, and is annually indexed to inflation. In addition, the AMT rate for 2024 and future years will be 20.5 per cent, up from 15 per cent, corresponding to the rate applicable to the second federal income tax bracket.
The federal budget included some amendments to the draft legislation, the most significant of which was that the tax treatment of charitable donations will be revised to allow individuals to claim 80 per cent (instead of the previously proposed 50 per cent) of the donation tax credit when calculating AMT.
With a federal donation credit rate (for high-income earners) of 33 per cent, 80 per cent of this credit rate works out to 26.4 per cent, which is higher than the AMT rate of 20.5 per cent, meaning that no AMT should arise on a simple charitable gift.
No changes, however, were made to the AMT inclusion rate for in-kind gifts of appreciated securities to charity. Under the regular tax system, donors who make in-kind donations to a registered charity of publicly listed shares and units or shares of mutual funds or segregated funds get a tax receipt equal to the fair market value of the securities being donated, and avoid paying capital gains tax on any accrued gain.
Under the draft legislation released in the budget, as previously announced, 30 per cent of the capital gains on donations of publicly listed securities will be included in the AMT base.