TaxMatters@EY: Family Wealth Edition – October 2023

Yiyun Chen, Toronto, and Gael Melville, Vancouver

Alternative minimum tax (AMT or minimum tax) may not commonly come up in conversations about tax. But with the federal government’s recent legislative proposals released on August 4, 2023, which implement major changes to the Canadian minimum tax regime, now is a good time to refresh your awareness of this often-overlooked subject.

This article provides a high-level overview of the existing minimum tax rules and the proposed changes, followed by an example demonstrating the impact of some of the key changes.¹ Although minimum tax applies to both individuals and certain trusts, here we focus on individuals.

Background

The minimum tax is designed to ensure that individuals, including certain trusts, with high gross income, who would otherwise pay little or no income tax because they have a significant number of certain tax preference items, pay at least a minimum amount of tax for the year.² Tax preferences are specific items that reduce taxable income or tax payable, such as the capital gains exemption or the tax credit for political donations.

This additional tax — that is, the amount of minimum tax in excess of the regular tax otherwise payable — is generally not a permanent tax. Minimum tax paid in one taxation year may be carried forward for up to seven years and used to reduce regular tax payable in a subsequent year, but only to the extent minimum tax payable in that subsequent year is less than regular tax payable. Your minimum tax carryover balance from previous years can be found on your most recent notice of assessment.

Since the introduction of the minimum tax regime in 1986, the relevant rules have not been substantially updated. The government has expressed concern that some high-income Canadians still pay comparatively little personal income tax as a share of their income, by making significant use of deductions and tax credits.

To address this, the government is making major changes to the minimum tax regime — the stated goal is to precisely target very wealthy individuals, ensuring they pay a share of tax proportionate to their income, while removing the application of AMT from most middle-class Canadians.³

Once enacted, the proposed changes will apply to taxation years beginning on or after January 1, 2024.

How is minimum tax calculated?

To better understand how the proposed rules may impact you, it is helpful to first understand how minimum tax is computed.

Broadly, the AMT requires a revised calculation of income (adjusted taxable income) and net minimum tax payable to be performed in parallel to the regular tax computation. The revised tax calculation follows a similar method to the regular tax calculation, with variations in how certain items are handled. In the revised calculation, you’d typically include larger amounts in income than you would for the regular tax computation, if applicable — for example, a higher capital gains inclusion rate applies for the minimum tax calculation — as well as reduce or omit certain deductions — for example, the calculation limits the amount of losses related to tax shelter investments.

Once you have calculated your adjusted taxable income, you then deduct the basic exemption amount from your adjusted taxable income — AMT does not apply to the basic exemption amount, which is currently $40,000.4 The calculated result is commonly referred to as your “AMT base,” which is taxed at a flat federal minimum tax rate, currently 15%. Then, you reduce the tax calculated from the last step by the total non-refundable tax credits that are allowed under AMT, referred to as the basic minimum tax credit. In addition, you may also deduct a special foreign tax credit, if applicable, when arriving at your minimum tax payable.

The result of this revised calculation is your federal minimum tax payable for the year. If your federal minimum tax payable is greater than your regular federal tax payable, you must pay the minimum tax. Provincial taxes are also calculated on the revised federal amount.5

What are the proposed changes?

The proposed rules make several changes to the application of minimum tax. On the one hand, tax preference items will be further limited; the basic minimum tax credit you may claim will be reduced, and the AMT rate will increase. On the other hand, you’ll be allowed to claim a much higher basic exemption amount. Also, more types of trusts will be exempt from the application of minimum tax.

The key changes are summarized below.

1.  Limitations on tax preferences

Capital gains (and losses): Under the proposed rules, you must include 100% of capital gains and current-year capital losses in your adjusted taxable income. This is increased from 80% under the existing rules. This will also apply to any capital gains allocated to you from a trust.

If you have capital gains arising from donations to a registered charity or to another qualified donee, you must generally include 100% of those gains in your adjusted taxable income under the proposed rules.6 Under the current rules, you do not need to make adjustments to such gains when computing your adjusted taxable income for minimum tax purposes.

The only exception is if the properties donated are certain publicly listed securities — in that case, you’ll only need to include 30% of the relevant capital gains in your adjusted taxable income.

Allowable business investment loss (ABIL):7 If you claim an ABIL for purposes of computing your regular tax, you may claim the same amount for minimum tax under the proposed rules (i.e., 50% of the business investment loss). This is reduced from 80% that is currently permitted for minimum tax purposes.

Capital gains deduction: Under the current rules, if you have a capital gain from a disposition of property that is fully sheltered by the lifetime capital gains exemption (LCGE), you may claim the same capital gains deduction for minimum tax as you claim for regular tax. This means the net inclusion rate for such gains is currently 30% for minimum tax purposes, while the inclusion rate is generally 0% for regular tax purposes.8

The government intends to maintain this 30% rate for minimum tax purposes. Therefore, to offset the effect of the proposed 100% capital gains inclusion rate, the amount of the capital gains deduction is multiplied by 1.4, so the net inclusion rate remains unchanged.9

Stock option deduction: Under the current rules, if you receive employee stock option benefits eligible for the one-half stock option deduction for regular tax purposes, you must effectively include 80% of those benefits in adjusted taxable income. Under the proposed rule, you must include 100% of the benefit.

There is one exception. If you make a donation of optioned shares that are publicly listed securities, and the donation is made to a registered charity or other qualified donee within 30 days after the shares were acquired, you must include 30% of those benefits for minimum tax purposes under the proposed rules. Currently such benefits are fully exempt from minimum tax (same as regular tax).

Unused losses from other years: The proposed rules will limit your ability to use certain losses carried forward from other years:

•  You may only deduct 50% of unused non-capital losses or unused limited partnership losses that you deducted for purposes of computing your regular income, instead of the current 100%.10

•  You may deduct the same unused net capital losses you deducted in computing your regular tax payable (that is, using a 50% inclusion rate), lowered from the current 80% inclusion rate.11 This means that, for minimum tax purposes, while you must include 100% of capital gains in income, you may only apply 50% of unused capital losses from other years against those capital gains.

Other deductions: Under the proposed changes, you may only claim 50% of certain deductions for minimum tax purposes, instead of 100%. While some of these deductions may not be common, below are a few that are frequently encountered:

•  Certain employment expenses, such as eligible travel expenses and professional dues.

•  Interest and financing expenses incurred to earn income from property. For certain expenses that are currently limited under specific AMT rules, such as interest or financing expenses claimed on rental or leasing properties, the current restrictions will continue to apply.

•  Moving expenses.

•  Child care expenses.

You can continue to claim 100% of deductions that are not specifically restricted under the revised minimum tax rules, such as the RRSP deduction and the deduction for support payments made.

2.  Basic exemption amount

The basic exemption amount you can claim will increase from $40,000 to the amount that corresponds to the lower threshold of the fourth federal income tax bracket, which is indexed annually to inflation and is expected to be approximately $173,000 in 2024.¹²

3.  Minimum tax rate

Under the proposed measures, the flat federal minimum tax rate will be increased to 20.5% (from 15%).

4.  Tax credits

While the types of non-refundable credits you may claim to lower your minimum tax are restricted, currently you are entitled to claim 100% of those that are permitted — for example, the charitable donations credit, the basic personal credit, and the medical expenses credit. However, under the proposed rules, you may claim only 50% of the permitted credits.

On the other hand, under the proposed rules you may claim additional credits, at the proposed 50% rate, that are not currently allowed. These credits include the pension credit, tuition credit transferred to you, and disability credit transferred to you.

Other credits that are not currently permitted will remain the same. These include the dividend tax credit, investment tax credit, and political contribution tax credit.

5.  Trusts

Currently, minimum tax applies to most types of trusts, with some exceptions. Under the proposed rules, more types of trusts will be exempt from the application of minimum tax. Most notably, graduated-rate estates will no longer be subject to minimum tax under the proposed amendments.

No changes are proposed to the seven-year carry-forward period.

The above summary captures the key changes in the proposed AMT rules. If you want to learn more about the new rules or other changes not covered above, please contact your EY advisor.

Example of the proposed AMT rules¹³

Emma owns an incorporated small business that she has decided to sell. The shares she holds are qualified small business corporation (QSBC) shares, meaning that they qualify for the LCGE. Emma has not used any of her LCGE in the past.

In 2024, Emma sells her shares, realizing a capital gain of $1,715,865, of which $1,015,865 can be fully sheltered by the LCGE.¹⁴ At the end of 2024, she has unused net capital losses of $100,000 from previous years. The only non-refundable credit she is entitled to claim in 2024 is the basic personal amount.

Emma’s regular taxable income and the revised AMT taxable income under the current and proposed rules are calculated and compared below. Provincial minimum tax is ignored for purposes of the example.

Under the current rules, since Emma’s federal minimum tax computation yields a larger result than her regular tax payable computation, Emma would have to pay total federal tax of $97,593. She would have a minimum tax carryover of $41,476. Under the proposed rules, Emma would have to pay total federal tax of $148,950; she would have a minimum tax carryover of $92,833. The application of the proposed rules to Emma’s situation would result in an extra $51,357 of tax being payable.

In the example above, the proposed rules require significantly more cash in a year to fulfill the minimum tax obligation. While Emma may be able to recover the additional AMT during the seven-year carryover period, she may need to undertake additional planning to make sure she has sufficient regular income in the carryover period to recover the AMT paid in respect of the 2024 taxation year.

Conclusion

While minimum tax applies only to a limited number of taxpayers each year, in light of the proposed changes, it is important not to overlook it in your tax planning. In particular, if you’re planning to sell QSBC shares and you expect to realize a large capital gain after 2023, remember to factor in any minimum tax liability. Also, if you anticipate receiving sizable stock option benefits after 2023, consider the minimum tax implications when you’re thinking about when to exercise the options.

Consult your EY advisor to make sure you understand your potential exposure to minimum tax.  

1. The draft legislation was open for public consultation until September 8, 2023; the final version of the proposals may differ from the one published on August 4, 2023. This article is based on the proposals as published.
   
   
2. AMT does not apply to individuals in the year of their death, nor does it apply to the special separate returns that may be filed on behalf of bankrupt or deceased individuals.
   
   
3. The federal government first announced its intention to examine a new minimum tax regime in the 2022 federal budget. The key design features of the new regime were revealed in the 2023 federal budget and detailed measures were subsequently released on August 4, 2023. See EY Tax Alert 2023 Issue No.20, Federal budget 2023-24, for more information.
   
   
4. Only an individual may claim the basic exemption amount. It is not available to trusts, with the exception of graduated-rate estates (under the current rules) and qualified disability trusts (under the proposed rules).
   
   
5. Form T691, Alternative Minimum Tax, is used to calculate AMT, and the calculation is embedded in most tax preparation software.
   
   
6. Note that a capital gain arising from the donation of ecologically sensitive land is excluded from adjusted taxable income under both the current and proposed AMT regime.
   
   
7. An ABIL is a special type of capital loss that can be used more flexibly than an ordinary capital loss for a limited period of time. Unlike allowable capital losses, which may be deducted only against taxable capital gains, an ABIL may offset income from any source in the year the loss is incurred. For regular tax purposes, an ABIL is 50% of a business investment loss. A business investment loss can only arise on the arm's-length disposition of shares or debt of a corporation that was a small business corporation at any time during the preceding 12 months before the disposition.
   
   
8. The 30% is the difference between the 80% capital gains inclusion rate under the current AMT rules and the 50% capital gains deduction allowed under the current AMT rules.
   
   
9. For example, a $100,000 capital gain would be offset by a capital gains deduction of $70,000 (being $100,000 x 50% x 1.4), resulting in a net gain of $30,000, or an effective inclusion rate of 30%.
   
   
10. Non-capital losses may be carried back three years and forward 20 years. Limited partnership losses may be carried forward indefinitely but cannot be carried back to previous years.
    
    
11. Net capital losses may be carried back three years and forward indefinitely.
    
    
12. The estimated amount is mentioned in the 2023 federal budget documents.
    
    
13. For credits and exemptions subject to indexation, the calculation assumes an indexing rate of 4.6% for 2024, based on the estimated lower threshold of the fourth federal income tax bracket of $173,000 in 2024 (i.e., $173,000/$165,431 (lower threshold of the fourth tax bracket in 2023)) = 1.046.
    
    
14. $971,190 (maximum LCGE on QSBC shares for 2023) × 1.046 = 1,015,865 (estimated maximum LCGE for 2024).
    
    
15. Under the proposed rules, 100% of capital gains are included in income for minimum tax purposes.
    
    
16. Under the proposed rules, unused net capital losses from other years that are deductible in the current year are the same as for the computation of regular tax (i.e., $100,000), compared to 80% under the current AMT rules, i.e., $100,000 × 2 × 80% = $160,000.
    
    
17. Under the proposed rules, capital gains deduction can be grossed up by 1.4 for minimum tax purposes: $1,015,865 LCGE × 50% = $507,933; Grossed up by 1.4: $507,933 × 1.4 = $711,106.
    
    
18. The regular federal tax is calculated based on the estimated income tax brackets for 2024.
    
    
19. Under the proposed rules, only 50% of regular non-refundable tax credits can be claimed for minimum tax purposes.

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