Alternative Minimum Tax - does it impact me?
Another calculation of your tax payable - and how to plan for it
As if regular income tax calculations aren’t complicated enough - now we have to worry about a completely separate, “alternative” way to calculate it! In Canada - and in many other countries around the world - there are two ways for taxpayers to calculate their tax payable. The method most people are aware of, i.e. the regular income tax, and the second method, the alternative minimum tax.
Whichever of the two methods results in a higher tax payable is the one that applies in any given year.
What is the Alternative Minimum Tax, or AMT?
We will limit our discussion to individuals and trusts, but similar rules apply to corporations in Canada as well.
The purpose of the AMT is to make sure that certain taxpayers who benefit from tax deductions still pay at least a minimum amount of tax, at a rate that the government has decided is “fair” in any given year.
It is designed specifically to prevent what the government considers “high income earners” from using tax credits and deductions to significantly reduce their tax liability.
Who does it typically apply to?
The Alternative Minimum Tax has no effect on most Canadians. Most people likely do not even know it exists. If you use tax software to prepare and file your tax returns every year, the tax software considers AMT, whether you know it or not!
However, if you are an individual, trust, or estate who are in a special situation where your tax bill is considered too “low” in any given year, AMT may apply to you.
It is generally a very unpleasant surprise to most people when it comes up, and it is too late to do anything about it when the taxation year is over and you’re preparing your tax returns. However, if you are aware that it may be an issue, there are things you can do to plan for it.
We discuss how it is calculated, and what some of these points are, below.
How to Calculate AMT
AMT is calculated first by starting with the taxpayer's net income, as ordinarily calculated. Then, certain adjustments are made to add back specific tax “preferential items”. The most common items include the non-taxable portion of capital gains, business investment losses, stock option deductions, and the non-taxable portion of dividends. This is nowhere near an exhaustive list!
Then, the AMT rate is applied to the amount of this adjusted income that exceeds the particular year’s “exemption”. If that calculation results in a higher tax payable than the tax liability calculated under the “regular” method, you will have to pay the higher of the two - you’ve fallen into the AMT trap!
Of particular note, in 2024, the AMT rate increased from 15% to 20.5%.
These are some of the items that can Trigger Alternative Minimum Tax. If you have enough of one or more of these items in any given year to be concerned, please reach out as described below and we can discuss what your options are:
Net Capital Gains
Employee Stock Option deductions
Tax Shelter Deductions (flow-through share deductions, resource partnerships, etc)
Limited Partnership Losses
Excessive Business Loans
Certain depreciation deductions on Rental Properties
Dividends
Investment Tax Credits
Deduction for employee home relocation loan
Exemptions and Adjustments
As noted above, there is a basic exemption that reduces the adjusted income subject to the AMT. In 2024, it increased from $43,000 to $173,000. This helps prevent less middle-income taxpayers from being subject to the tax, while ensuring that higher income earners pay a higher rate of AMT than prior years.
Carry Forward Mechanism
If a taxpayer pays AMT in one year, they are able to use it as a credit against regular income tax in future years, for up to seven years after the year in which it arose.
This ensures that taxpayers are not permanently penalized if their tax situation fluctuates from year to year and they happen to be caught by AMT in one year but not in future years.
Tips and Ideas
In some cases, AMT can cause real problems if it is unlikely to be creditable in future years. In such circumstances, increasing tax payable in the applicable year to ensure that the AMT does not apply can be more beneficial.
If this is a concern, consider the following:
Reduce or defer discretionary deductions: Reducing discretionary deductions such as RRSP deductions or capital cost allowance claims by deferring them to future years can increase your tax payable in a certain year, but reduce or eliminate the AMT.
Take a salary or bonus from your corporation, instead of dividends.
Investment planning: Managing the timing of capital gains and stock options can reduce the impact of the AMT.
We can work with you to model various outcomes and how choosing to defer or reduce deductions can help manage your potential AMT.
Do you want to understand more about the AMT? Do you need help with planning for a possible AMT problem?
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