Alternative Minimum Tax

First introduced in 1986, the Alternative Minimum  Tax (“AMT”) is a parallel tax calculation for  individuals (and many trusts) which calculates  an alternate taxable income that allows fewer  deductions, exemptions, and tax credits than under  the ordinary income tax rules. 

The AMT calculation applies a flat 20.5% tax rate on this  adjusted taxable income with a standard exemption amount  ($173,205 per individual in 2024 and indexed annually;  expected to be $177,882 for 2025) instead of the normal  progressive rate structure. A taxpayer ultimately pays the AMT  or regular tax, whichever is highest. Additional tax paid as a  result of the AMT can generally be carried forward for seven  years and can be credited against regular tax to the extent  regular tax exceeds AMT in future years. The AMT does not  apply in the year of death.

The AMT is designed to ensure that high income earners pay a minimum amount of income tax each year and cannot  artificially reduce their taxable income through excessive  use of deductions or credits. However, as initially highlighted  in its 2021 Election Platform, the Liberal government was  concerned that the previous AMT regime was not achieving  this policy objective. Therefore, in its 2023 Federal Budget  – and subsequent announcements¹  – several changes were  proposed to the AMT calculation, with the stated goal of  better targeting high-income individuals by broadening  the AMT Base, further limiting tax preference items and  increasing the AMT tax rate. As these changes were formally  enacted and effective for 2024, this report highlights key  design features of the new AMT regime, including what has  changed, and provides examples where the AMT may apply.

How is AMT calculated?

The AMT regime imposes a complex calculation that adjusts  the “ordinary” taxable income of an individual (or trust) by  limiting deductions, exemptions, and tax credits that would  otherwise be allowed for regular tax purposes, and applying  a minimum tax rate over a threshold amount. In theory,  the calculation would apply to all individuals, although  only taxpayers with higher gross incomes (especially those  claiming substantial deductions, exemptions or credits) would  be subject to AMT.

In simplified terms, the AMT is determined by a formula that  operates as follows:

Where:
A: the AMT Rate; Is multiplied by the difference between
B: AMT Income; and
C: the AMT Exemption. This amount is reduced by
D: AMT Credits To determine
E: the AMT Amount.

If the AMT Amount is greater than the regular tax calculation,  then AMT is paid. The AMT in excess of regular tax can  generally be carried forward for seven years and can be  credited against regular tax to the extent regular tax exceeds  AMT in those years.

The AMT is calculated federally, and a companion “provincial  AMT” is separately calculated in all provinces and territories,  typically as a simple percentage of the Federal AMT.

What has changed to the AMT calculation for individuals effective 2024?

As previously noted, legislative amendments originating from the 2023 Federal Budget resulted in several changes to the AMT 
calculation, with the stated goal of better targeting high-income individuals. Accordingly, beginning in 2024, there are significant 
changes to each of the components of the formula, as follows:

What are the key changes to the calculation of AMT Income?

AMT Income is determined in a similar manner to an individual’s regular income tax calculation, albeit with some significant  differences in the percentage applied to the amount included, deducted, or excluded from income for AMT purposes. For  example, although only 50% (or potentially 2/3, after June 24, 2024) of a capital gain realized (e.g., on the sale of a publicly-traded security) is included in income for regular tax purposes, 100% of the capital gain is now included in income for AMT  purposes (an increase from 80% prior to 2024).

The following list, while not exhaustive, highlights some of the key percentages used for regular tax purposes in comparison  with the previous and new AMT percentages:

Example scenarios

The combined effect of the above changes to AMT income inclusions, the AMT Rate and AMT Credits, will result in a number  of scenarios where the AMT will now apply when it did not before. While this effect will be largely offset for most individuals  due to the increased AMT Exemption, individuals who receive a significant portion of their income in a particular year from  preferential sources (such as Canadian dividends or pre-June 25, 2024 capital gains) will be most impacted, especially those  who can claim significant deductions or credits to reduce their regular income tax otherwise payable. This is particularly true for  charitable high-income earners who donate securities, since the recent changes will reduce the donation tax credit to 80% and  increase the inclusion rate to 30% (vs. 0% previously) of capital gains incurred when donating publicly-traded securities, for the  purposes of the AMT calculation in 2024, and thereafter.

For example, take the case of an individual who realizes a $2,000,000 capital gain (prior to June 25, 2024), with no other source  of income, who then chooses to donate $200,000 of publicly-traded securities (with a $100,000 adjusted cost base).

Under this scenario, the changes to the AMT would result in over $89,000 in additional Federal tax, whereas previously the AMT  wouldn’t have resulted in any additional taxes in excess of the “regular” tax. However, if the capital gain in this scenario was  realized after June 24, 2024, such that most of the gain was subject to a 2/3 capital gain inclusion rate, AMT would not apply (as  the regular tax would be higher due to the increased capital gains inclusion rate, which exceeds the Federal AMT rate.)⁶ However, more modest income earners who make donations of securities shouldn’t be subject to the new AMT, such as the  following scenario, where an individual earning $200,000 of employment income, donates $20,000 of appreciated securities (with a $10,000 cost base).

How does AMT apply to trusts?

Generally, the AMT rules apply to trusts that are not “exempt trusts” in much the same manner as they do for individuals, with a  key difference being that most trusts are not eligible for the AMT Exemption.

Exempt trusts are excluded from the application of the AMT. They generally consist of registered plans (such as RRSPs), various  investment funds (such as mutual fund trusts), as well as certain alter ego and joint partner trusts.⁷ Beginning in 2024,  graduated rate estates have been added to the list of exempt trusts, which should reduce the complexity of post-mortem tax  planning and compliance for executors.

Also, while not an exempt trust, qualified disability trusts will have access to the expanded “basic exemption” (i.e., $173,205 per  individual in 2024 and indexed annually; expected to be $177,882 for 2025) that is otherwise only available to individuals.

However, trustees of other (non-exempt) trusts, such as family trusts, will need to consider if their trust will have exposure to  the AMT due to the broadening AMT income base. For example, interest expense was previously 100% deductible for regular  and AMT purposes, but will (generally) be only 50% deductible for AMT purposes in 2024, and later years. Therefore, a family  trust, including those holding a prescribed rate loan, may have AMT Income under the recent changes. Consequently, an AMT  liability may arise, even though the trust has allocated all of its regular income to beneficiaries to be taxed in their hands.

What planning should be considered if there is potential for AMT exposure?

While the changes outlined can increase the incidence (and impact) of AMT to many higher-income Canadians, particularly where 
significant deductions (such as the lifetime capital gains exemption) are claimed, there are some key points to remember:

• The AMT Exemption is $173,205 per individual in 2024 (indexed annually; expected to be $177,882 for 2025) – which will mitigate the concern for most low-to-modest income individuals, in most years;
• The AMT does not apply to corporations – so higher-income taxpayers with existing investment holding companies may wish to consider making their charitable donations (of cash or securities) through their corporation and/or controlling the amount  and type of income they receive personally from their corporation to take into account possible AMT;
• The AMT also does not apply in the year of death – so affected donors may wish to consider charitable bequests in their Will;
• If AMT is payable in a particular year, it may be recovered in the following seven years, particularly in future years where sufficient non-preferential sources of income (such as interest or employment income) will be earned, or lower deductions/credits will be claimed;
• For discretionary trusts that have an AMT exposure, consider (in consultation with your tax advisor) leaving some income to be  taxed in the trust instead of fully allocating to the beneficiaries, in order to avoid AMT or to leave sufficient funds in the trust to pay the AMT liability.

Seek advice

The main takeaway is to better understand how these important changes to the AMT may affect you and/or your family trust (i.e., whether AMT is potentially applicable in your specific situation), and if so, whether it can be recovered in the seven-year carryforward period. Given the complexity of the AMT, it is recommended that you work with your tax advisor to prepare a ‘pro-forma’ tax calculation each year to determine the potential application (and future recoverability) of the AMT in your particular situation.

Please contact your BMO Private Wealth professional if you have any questions about your wealth planning. 

 

¹ The Federal government subsequently released further proposed changes to the AMT legislation in August 2024 to remove limitations on claiming resource expense deductions in full, which is expected to increase the attractiveness of flow-through shares for both investors and issuers. Please consult with your tax advisor for the current status of this legislation and the potential impact to your particular situation.
² The basic AMT exemption increased from $40,000 in 2023 to the start of the second-highest Federal tax bracket – which is $173,205 in 2024 (and is expected to be $177,882 for 2025).
³ 80% of regular donation tax credit. For regular tax purposes, the Federal donation tax credits are valued at 15% of the first $200 of gifts, and 33% of the remainder, where taxable income exceeds the top marginal tax bracket. Note that annual donation claims are limited to 75% of net income (100% in the year of death).
⁴ Other tax credits includes only the basic personal amount in Scenario 1, and the basic personal amount, as well as the CPP, EI and Canada Employment amounts in Scenario 2.
⁵ Only the Federal AMT is presented for illustration purposes. All provinces and territories impose a minimum tax and, in most provinces, the provincial AMT component is represented as a percentage of the Federal AMT.
⁶ Since the new flat AMT rate for 2024 of 20.5% exceeds the top Federal regular tax rate on capital gains subject to a 50% inclusion rate (i.e., 16.5% = 33% x ½), many individuals with large capital gains who claim offsetting deductions, exemptions or credits to substantially reduce their regular tax liability may be subject to the AMT in 2024 (as illustrated). However, the potential higher capital gains inclusion rate of 2/3 will lessen the likelihood of AMT applying in these scenarios after June 24, 2024, since the top Federal regular tax rate on capital gains will increase to 22% (i.e., 33% x 2/3 inclusion rate), which exceeds the new flat AMT rate of 20.5%.
⁷ Alter-ego and joint partner trusts may be exempt from the AMT in the year that a deemed disposition arises on death pursuant to 104(4) of the Income Tax Act.

 

 

BMO Private Wealth is a brand name for a business group consisting of Bank of Montreal and certain of its affiliates in providing private wealth management products and services. Not all products and services are offered by all legal entities within BMO Private Wealth. Banking services are offered through Bank of Montreal. Investment management, wealth planning, tax planning, philanthropy planning services are offered through BMO Nesbitt Burns Inc. and BMO Private Investment Counsel Inc. If you are already a client of BMO Nesbitt Burns Inc., please contact your Investment Advisor for more information. Estate, trust, and custodial services are offered through BMO Trust Company. BMO Private Wealth legal entities do not offer tax advice. BMO Trust Company and BMO Bank of Montreal are Members of CDIC.

^® Registered trademark of Bank of Montreal, used under license.