When the alternative minimum tax applies
The alternative minimum tax (AMT) is a parallel tax calculation that allows fewer deductions, exemptions and tax credits than the ordinary income tax rules. The taxpayer pays the AMT or their regular income tax, whichever is highest.
The AMT was introduced in 1986 as a way to bring more fairness to the Canadian tax system, in that it was designed to prevent high-income earners from paying little or no tax. There are several tax shelters and tax deductions that can, in some circumstances, lead to high earners significantly lowering the tax they pay. Common instances where AMT could apply include when the lifetime capital gains exemption is claimed on a sale of shares and where there are large amounts of employee stock options.
You may also have to pay provincial alternative minimum tax, which is calculated separately from federal tax.
The AMT carry-over provision
You are allowed to carry forward the difference between the AMT amount you paid and what you would have paid using the regular tax calculation method, for up to seven years. This amount can be used to reduce your regular tax bill over the next seven years, up to the amount your regular income tax exceeds your AMT calculation.
Who will the alternative minimum tax affect?
Typically, the AMT only affects around 70,000 people (and this figure is expected to drop to 32,000 after the changes from the 2023 budget come into effect). It normally impacts high income earners and often applies to business owners who take advantage of the lifetime capital gains exemption when selling the shares of their company.
Individuals have to calculate the amount of tax they owe using both the regular method and the AMT method and then pay the higher of the two amounts.
If you’ve used significant tax exemptions, deductions or credits, you may find that you’ll have to pay taxes according to the AMT calculation.
What impact will the 2023 budget have on the alternative minimum tax?
There are a few key changes proposed in the 2023 budget, which will affect how many people will pay AMT and how much they’ll pay. While the number of Canadians who will be subject to AMT is expected to be reduced by over half, the government expects to generate an extra $2.95 billion in taxes from the new AMT over the next five years.
Changes to the alternative minimum tax include increasing the AMT tax rate from 15% to 20.5% and raising the AMT exemption from $40,000 to the start of the fourth federal tax bracket (approximately $173,000 for the 2024 tax year), which will be indexed to inflation annually.
Budget 2023 also proposes to broaden the base to which AMT applies by:
- Increasing the AMT inclusion rate on capital gains from 80% to 100%. Capital loss carry-forwards and allowable business investment losses would apply at a 50% rate.
- Including 100% of employee stock option benefits.
- Including 30% of capital gains on donations of publicly listed securities. The 30% inclusion rate would also apply to the full benefit associated with employee stock options, whenever a deduction is available because the underlying publicly traded securities were donated.
The new rules would also broaden the AMT base by disallowing 50% of several deductions, including:
- Employment expenses, other than those to earn commission income.
- Deductions for the Canada Pension Plan, Quebec Pension Plan and provincial parental insurance plan contributions.
- Moving expenses.
- Child care expenses.
- Disability supports deductions.
- Deductions for workers' compensation payments.
- Deductions for social assistance payments.
- Deductions for Guaranteed Income Supplement and Allowance payments.
- Canadian armed forces personnel and police deductions.
- Interest and carrying charges incurred to earn income from property.
- Deductions for limited partnership losses of other years.
- Non-capital loss carry-overs.
- Northern residents deductions.
Budget 2023 also proposes that only 50% of non-refundable tax credits will be allowed to reduce the AMT (apart from limited exceptions). The proposed AMT calculation would use the cash value of dividends and completely disallow the dividend tax credit.
What to do if you expect to have to pay AMT
You should talk to your accountant to find out if AMT will apply to you and, if it does, discuss ways to minimize it. If AMT applies, work with your financial planner to determine how to best use the AMT carryforwards over the following seven years to minimize its overall impact.
Be prepared for the alternative minimum tax
Talk to your IG Advisor about the alternative minimum tax and whether it’s likely to impact you. They’ll be able to help you work out how your financial plan fits in with any income that might be subject to AMT. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.