Alternative minimum tax (“AMT”), introduced in 1986, was designed by the Department of Finance to ensure that high-income taxpayers could not structure
their affairs to pay little or no tax. The concept behind AMT is to reduce or eliminate certain tax preferences available as part of the general taxable income calculation in a particular year. In this fashion, an alternative amount of “ordinary income” is calculated and will be subject to tax for that particular year.
In order to ensure fairness in the system, to the extent an individual had to pay AMT in a particular year, the excess amount can be carried forward and claimed as a refund when AMT is less than regular tax within the subsequent seven years.
In general terms, the AMT calculation begins with the individual’s taxable income as reported under the general rules, then adds back certain tax referred
items and deducts other taxable income adjustments to arrive at an adjusted taxable income amount for AMT purposes. This adjusted taxable income is then reduced by the “basic exemption” of $40,000 to derive net adjusted taxable income for the individual. The basic exemption is not indexed like other amounts in the Income Tax Act.
Two of the AMT adjustments that increase taxable income are:
- Losses on certified film and rental/leasing properties, to the extent the losses were created by a claim for capital cost allowance (CCA); and
- A portion (30%) of the individual’s net capital gains, except those gains attributable to mortgage foreclosures or gifts of capital property.
By adding back 30% of the net capital gain, the calculation brings 60% of the non-taxable portion of the net capital gain into the AMT calculation.
|Original Tax Calculation||AMT Calculation|
|Taxable income as reported included a $375,000 taxable capital
gain triggered by the crystallization of the individual’s enhanced capital
|Add back 30% of net capital gains reported (30% of 750,000)||225,000|
|Adjusted taxable income||325,000|
|Less: AMT exemption||40,000|
|Net adjusted taxable income||285,000|
|Tax rate (the federal government imposes AMT at 15% and the provincial
governments will add a further amount)
|Normal marginal rates||15% (fed) + provincial rate|
|Income tax liability (combined fed/prov amount)||$28,152||$63,205|
Note: provincial rate and resulting tax liability will differ by province.
In the example above, the individual incurred an additional tax liability of $35,053 under the AMT calculation because he or she claimed the enhanced capital gains exemption in an otherwise low income environment. This is a large amount of additional tax given that no cash flow was generated by the crystallization strategy.
If the individual’s other income remained constant at $100,000, he or she would be able to reduce the regular income tax liability in the subsequent year by $10,678 federally and $3,625 provincially, resulting in a net income tax liability of $12,178 in the subsequent year. If nothing else changes, it will take this individual over two years to recover the AMT tax because of the impact of the crystallization of his or her enhanced capital gains exemption.
Tax planning should involve managing the entire situation, and the impact of AMT should not be overlooked, even in years where regular income is not particularly high.
E.O. & E.
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Contributors to this edition:
James W. Kraft, cpa, ca, mtax, tep, cfp, clu, ch.f.c.
Deborah Kraft, mtax, tep, cfp, clu, ch.f.c.