Fasken's Private Client Services practice group is committed to providing our clients with clear, actionable insights into the evolving tax landscape. The Canadian government's recent changes to the Alternative Minimum Tax (AMT) are particularly relevant for high-net-worth individuals, trusts, and estates (other than graduated rate estates). This article outlines some key aspects of the new AMT regime and offers strategies to mitigate its impact.
Understanding the Alternative Minimum Tax
The AMT is designed to ensure that taxpayers with substantial income pay a minimum level of tax, regardless of deductions, credits, or other tax benefits available. It operates alongside the regular income tax system, requiring taxpayers to calculate their tax liability under both systems and pay the higher amount.
The AMT exists in both the United States and Canada, but they are distinct systems under each country's tax laws. While both systems share the goal of preventing high-income earners from paying disproportionately low taxes, the specific rules, rates, and implementation differ between the two countries.
In Canada, the AMT primarily targets high-income individuals and certain trusts. It ensures that each of these pays at least a minimum level of tax, regardless of the deductions and credits they might claim under regular tax rules. The AMT in Canada recalculates income using a broader base and applies a flat tax rate to this adjusted taxable income calculation.
Key Changes in the New AMT Regime
Increased AMT Rate
The new regime increases the federal AMT rate to 20.5%, potentially impacting those who rely heavily on tax deductions and credits such as charitable donation tax credits, net capital loss carryforwards, and financing expenses on amounts borrowed to make investments.
Broader Base
The AMT base has been expanded, reducing the effectiveness of many traditional tax planning strategies. This includes increasing the inclusion rate on certain gains, such as gains on donated property, and decreasing the portion of certain credits and deductions that are available under the regular tax calculation.
Higher Exemption Threshold
The basic exemption for AMT has been increased from $40,000 to $173,2024 for 2024. That amount will be indexed to inflation going forward. This increase may benefit some taxpayers but may still lead to higher overall taxes or unrecoverable taxes for those with complex financial arrangements.
Impact on High-Net-Worth Individuals
Ultra-high-net-worth (UHNW) individuals, particularly those who rely on various deductions and credits may be most affected by these changes. Trusts, often used in estate planning and wealth transfer, may also face new challenges under the AMT framework. So will estates after 36 months, when they are no longer graduated rate estates.
Strategic Considerations for Mitigating AMT Impact
Reviewing and Adjusting Tax Planning Strategies
Given the expanded AMT base and higher rate, it is crucial to review and potentially adjust your tax planning strategies. This may involve reconsidering the timing of income recognition or exploring alternative investment vehicles that offer better after-tax returns under the new regime.
Example: A taxpayer with capital losses carried forward might traditionally recognize these in years when they have capital gains. Under the new AMT regime, this strategy may not be as effective in a low-income year. Instead, the taxpayer could recognize the losses in a year when there is higher employment or other income, to minimize the exposure to AMT.
Utilizing AMT Credits
The AMT paid in a given year can be credited against future regular tax liabilities for seven years. Properly managing these credits can help mitigate the long-term impact of the AMT. It is advisable to work with tax professionals to develop a strategy for optimizing these credits over time.
Example: Suppose a taxpayer pays $50,000 in additional tax as a result of AMT in a particular year. This amount can potentially be credited against their regular tax liability in the seven subsequent years if their regular tax exceeds the AMT in those years. To effectively utilize this credit, the taxpayer could plan to generate taxable income in future years—such as by paying out bonuses and salaries, withdrawing from RRSPs, or generating interest income through bonds and other fixed income instruments. These strategies may result in a regular tax liability exceeding the AMT, thus allowing for use of AMT credits to reduce overall taxes paid in those years.
Reassessing Charitable Giving and Other Deductions
While charitable donations remain a valuable tool for philanthropy, the new AMT rules may limit their effectiveness in tax planning. It is important to reassess the timing and structure of such contributions to ensure they provide the desired tax benefits. This may also apply to other deductions and credits that are now more restricted.
Example: A taxpayer who donates publicly traded securities with unrealized gains to a charity may find that under the new AMT rules, the charitable donation credit for these donations is limited. To maximize the benefit, they could consider transferring the securities to a Canadian-controlled private corporation (CCPC), and having the corporation donate the securities, since corporations are not subject to AMT. The capital gain on the securities will be added to the corporation's capital dividend account, and available for distribution to the taxpayer/shareholder tax-free.
Estate and Trust Planning
The impact of the AMT on trusts necessitates a review of current estate planning strategies. This includes considering the timing of distributions from certain trusts, and potential benefits of alternative arrangements that may offer more favorable tax outcomes.
Example: A family trust that holds investment assets might distribute income to beneficiaries in a way that minimizes the overall tax burden. Under the new AMT rules, the trust may need to reconsider the timing and size of distributions. For instance, the trust could distribute income to beneficiaries whose income would be otherwise be taxable at a rate at least equivalent to the AMT rate. This might be the case, for example, when a corporation pays an eligible dividend to a trust, and the trustees allocate that dividend to beneficiaries.
Navigating the New AMT Landscape with Expert Guidance
The complexities of the new AMT regime underscore the importance of proactive tax planning and professional advice. Changes made to the general anti-avoidance rule (GAAR) in 2024 and other tax rules should also be considered in any of the above scenarios or other tax planning. At Fasken's Private Client Services, we are dedicated to helping our clients navigate these changes with confidence. Our team of experienced tax advisors is equipped to provide personalized strategies that align with your financial goals and minimize tax liabilities.
Conclusion
The introduction of the new AMT rules represents a significant shift in the Canadian tax landscape, particularly for high-net-worth individuals and certain trusts. By understanding these changes and working closely with tax professionals, you can mitigate their impact and continue to optimize your financial strategy.
Our team of professionals is here to support you with tailored advice and comprehensive planning services, including Lori Bokenfohr who is a tax lawyer proficient in business succession planning, estates, and cross-border tax issues.
With over 950 lawyers across Canada, the UK, and Johannesburg, our team ensures that each client receives personalized and effective solutions tailored to their unique needs.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.