The alternative minimum tax (AMT) is a tax system that ensures high-income individuals pay a minimum amount of tax, especially those who benefit from certain tax incentives and deductions that reduce the tax they owe to very low levels.
The Canadian federal government has proposed significant alternative minimum tax changes in the 2023 Federal Budget. These changes could have implications for high-income individuals who receive income from tax-preferential sources or have significant deductions that reduce their tax liability under ordinary tax rules.
In this article, we will explore the key changes proposed in the 2023 Federal Budget regarding the alternative minimum tax and how they could impact individuals. We will delve into the details of these changes, discuss who they will affect, and provide insights on how individuals can navigate the new AMT rules. For purposes of this article, we will only focus on the federal alternative minimum tax but some provinces also impose a provincial AMT, which could increase the tax payable under AMT even further.
The alternative minimum tax is an alternative tax calculation system designed to ensure that high-income individuals pay a minimum amount of tax. The AMT is calculated on "adjusted taxable income," which is determined by making specific adjustments to the taxpayer's regular taxable income. As such, a parallel tax calculation is used that allows fewer tax deductions, exemptions, and credits than under the regular income tax calculation. As a result, it can result in a potentially higher tax liability for individuals subject to its provisions.
Generally, if the tax calculated under the AMT system is more than the amount calculated under the regular tax system, the difference is the alternative minimum tax owing for the tax year. If the AMT surpasses the regular income tax, any extra tax paid can be carried forward for up to seven years to offset regular tax to the extent that regular tax exceeds AMT in the carryforward period. Essentially, this allows individuals to view the AMT as an advance payment of taxes that can be recovered within a seven-year timeframe.
Under the current alternative minimum tax system, the tax rate is a flat 15%, and individuals are granted a standard exemption of $40,000.
The 2023 Federal Budget proposes significant changes to the alternative minimum tax regime. These changes aim to address perceived inequities and ensure a fairer taxation system for high-income individuals. Let's explore some of the key changes proposed in the budget and their potential impact:
The budget proposes increasing the AMT exemption from $40,000 to $165,430 for 2023 and $173,000 for the 2024 taxation year. The exemption would also be indexed to inflation. Due to the increase in the exemption amount, very few Canadians will pay AMT and even high-income Canadians may not pay AMT if their only source of income is fully taxable employment, professional, or business income.
However, despite the increase in the exemption, the budget also proposes raising the AMT rate from 15% to 20.5% of adjusted taxable income. These changes aim to strike a balance between providing relief for some taxpayers while ensuring a fairer tax system overall.
Several revisions are proposed in order to expand the AMT base by placing additional restrictions on tax preferences such as exemptions, deductions, and credits. The key changes include:
1. Changes to Capital Gains and Losses - under the proposed changes, the capital gains inclusion rate has increased from 80% to 100% for purposes of calculating AMT adjusted taxable income. This change could result in a higher AMT liability for individuals who receive a significant portion of their income from these sources.
At the same time, capital loss carry-forwards and allowable business investment losses have been decreased from 80% to 50% deductible for AMT purposes. This change would limit the offsetting of AMT liability through the utilization of capital losses and business investment losses. Let's look at an example to see how these changed would impact the AMT calculation from current to proposed rules.
In the following example, let's assume an individual will sell qualifying small business shares in 2024, that will qualify for the lifetime capital gains exemption (LCGE). The fair market value of the private company shares is $900,000 with a nominal adjusted cost base. In addition, the taxpayer will also sell other capital property with a fair market value of $600,000 with an adjusted cost base of $200,000, resulting in a capital gain of $400,000. In addition, the taxpayer has a net capital loss carryforward of $100,000 from a prior year.
As shown above, under the current rules, the taxpayer's minimum tax is $40,935 (amount in excess of regular tax) but the new AMT rules increase the taxpayer's minimum tax to $63,820.
2. Employee Stock Options Benefits - the proposed changes include 100% of employee stock option benefits in the calculation of adjusted taxable income for AMT purposes. Currently, only 50% of employee stock option benefits are included.
Let's assume that an employee exercises options to acquire publicly listed shares at an exercise price of $100,000 when the fair market value of the shares is $500,000, which means the stock option benefit is $400,000. Further, let's assume that these options qualify for the stock option deduction.
As shown above, under the current rules, the taxpayer's minimum tax is nil as the tax calculated under the regular tax is higher. However, under the new rules, AMT is $2,302.
3. Donations of Publicly Listed Securities - for donors making in-kind donations to registered charities of shares, the proposed changes will include 30% of the capital gains on these shares in the calculation of the adjusted taxable income for AMT. Currently, there is zero inclusion of these gains in the calculation of the AMT.
4. Deductibility of Non-Refundable Tax Credits - most non-refundable tax credits, which are currently fully deductible, would become 50% deductible. These changes could result in a higher AMT liability for individuals who rely on non-refundable tax credits to reduce their tax liability.
5. Disallowing Various Deductions - currently, most deductions are allowed in the calculation of the adjusted taxable income for AMT. The new rules under alternative minimum tax propose that the following deductions would be 50% disallowed. These include:
For a complete list of deductions that are now disallowed at 50%, refer to the link at CRA's website.
The proposed changes to the alternative minimum tax will primarily affect high-income individuals who receive income from tax-preferential sources or have significant deductions that reduce their tax liability under ordinary tax rules. Individuals who fall into the following categories may be particularly impacted:
As noted above, the proposed changes to the alternative minimum tax system will have various implications for affected individuals. Hence, it is essential for taxpayers to assess their potential AMT liability under the proposed changes to ensure accurate tax planning and compliance. For example, business owners who are considering tax planning strategies to generate a significant capital gain after 2023 should carefully evaluate the potential consequences of these proposals with their tax advisor. Likewise, individuals who are contemplating making substantial donations to registered charities need to assess how this will affect the AMT under both the current regulations and the proposed changes.
The proposed changes to the AMT computation rules would come into force for taxation years beginning in 2024.
The proposed changes to the alternative minimum tax in the 2023 Federal Budget aim to ensure a fairer taxation system for high-income individuals. The inclusion of additional income sources and deductions, along with changes to the exemption and rate, could result in a higher AMT liability for some taxpayers.
It is crucial for individuals who may be affected by the new AMT rules to stay informed and seek professional advice to understand the implications and plan their tax strategies accordingly. By working with qualified tax accountants, individuals can navigate the changes effectively and optimize their tax positions. If you are looking for an accountant in Hamilton for professional guidance, contact us today. We are here to help!
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