AMT Overhaul: A Guide to the New Alternative Minimum Tax Rules

The 2023 federal budget announced significant changes to the Alternative Minimum Tax (AMT) regime to better target high-income individuals. 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 come with unique nuances and implications for taxpayers. Familiarizing yourself with these changes is essential to making informed financial decisions, so we’ve put together the following comprehensive guide to help you understand how it’ll affect your tax situation going forward.

Understanding the Alternative Minimum Tax

AMT is an alternative method of calculating your taxes payable in a given 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 meaningfully reduce your ordinary taxes payable. 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 which will increase to $173,000 in 2024 (indexed annually).
• Capital gains and losses: Under the current AMT regime, the inclusion rate for the purpose of computing ATI is 80% for capital gains, capital losses and business investment losses (as compared to a 50% inclusion rate for computing ordinary taxable income). Under the new rules, 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, child care 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. With the exception of 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: Generally, stock option benefits are 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 on 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 fully use the AMT tax credit.

Example Scenarios

To illustrate the effect these rule changes will have on taxpayers, we’ve created a few examples that show how tax would be calculated as ordinary income tax, under the current AMT rules and under the new AMT rules:

Example 1 – LCGE

A taxpayer realizes a capital gain of $3,000,000 on the disposition of Qualified Small Business Corporation Shares (QSBC). The AMT impact under the old and new rules are as follows:

Based on the above, the taxpayer would be worse off under the new AMT rules. However, consider an alternative LCGE example where the taxpayer realizes a capital gain of $800,000 instead.

This example would have the taxpayer in a better tax situation under the new rules, which demonstrates how the new rules are intended to penalize higher income earners.

Example 2 – Donation of publicly traded securities

A taxpayer has accrued gains of $600,000 of its publicly traded securities. The taxpayer decides to sell $500,000 and make an in-kind donation for the remaining $100,000 to a registered charity. The AMT impact under the old and new rules as follows:

Since ordinary income tax exceeds AMT calculated under the current rules, no AMT will result. However, under the new AMT rules, there would be AMT of $27,556 ($58,133 – $30,577).

Example 3 – Employee stock options

A taxpayer exercises stock options that qualify for the stock option deduction. The stock option benefit is equal to $750,000.

Since ordinary income tax exceeds AMT calculated under the current rules, no AMT will result. However, under the new AMT rules, there would be AMT of $16,354 ($118,285 – $101,931).

Effects on the average taxpayer and trust

The new AMT rules appear to better target high-income earners that 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 is relying on the sale of investments or properties as a means of 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 have a significant impact to your cashflow 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 and not just the family trusts of high-income earners.

The bottom line

The new AMT rules represent a sizeable change in the in the Canadian tax landscape and their effects will be far-reaching. To make sure you’re up-to-date on how these changes will impact your situation, reach out to your DMCL advisor. They’ll walk you through if and how these rules will apply to you and make sure you’re well-positioned come their implementation.

[1] e.g., the basic personal amount, the spousal amount, the age amount, donations, medical expenses, etc.

Article written by Nav Pannu, CPA