Since the 1980s, parallel tax calculations have been quietly running behind the scenes, with the goal of ensuring high-income earners pay a minimum amount of tax. Proposed changes to this alternative minimum tax (AMT) system, announced in the federal budget earlier this year, could stir up some surprises on 2024 tax assessments.
Ali Spinner is a partner in Crowe Soberman's Tax & Estate Planning Group, a Fellow of the Chartered Professional Accountants of Ontario and a community volunteer. Here, she breaks down the changes to the AMT system proposed for 2024, and the potential impact of the new rules.* (*Information accurate of October 16, 2023; changes may be forthcoming once the regulations are finalized.)
What is the AMT?
While the alternative minimum tax system, or AMT, has been around since the mid-1980s, most people have never had to think about it. When we file taxes, the tax system runs a separate calculation in the back end—treating certain tax deductions and credits in different ways than the regular tax regime. This parallel calculation applies to individuals and trusts, not corporations. It is thought to have been introduced in response to optics that high-income earners were structuring their finances to avoid paying taxes.
As long as the total is less than the standard tax calculation, this alternate universe of the AMT doesn’t affect you at all. It would only come into play in certain scenarios, such as when family trusts were used to multiply the capital gains exemption amongst a family following the sale of a business or when a minor (with no employment income) was suddenly recording large amounts of investment income. In most other scenarios, the AMT would be lower than the regular tax calculation and therefore not a concern.
What changes are expected in 2024?
Based on details proposed in the federal government’s 2023 budget (as of the time this article was published, we have not received the final legislation yet), we can expect three major changes:
- The federal AMT taxation rate will increase from 15% to 20.5%—and we can anticipate a corresponding change on the provincial side.
- The AMT “base” is changing, with a greater percentage of capital gains now included in the AMT calculation, along with a reduced percentage of deductions, notably:
- 100% of capital gains (versus 80% currently);
- 30% of capital gains from donated securities (versus 0% currently);
- 50% of certain deductions, such as interest and investment fees (versus 100% currently);
- 50% of non-refundable tax credits, such as charitable donations (versus 100% currently).
- The AMT income exemption is increasing from $40,000 to $173,000. So as of 2024, if your annual income is lower than $173,000, the AMT will not apply to you. This means many people will be taken out of the AMT system entirely.
Who will be most affected by these changes?
Anyone with an annual income over $173,000 who has a significant amount of tax-preferential income (such as capital gains) could face a higher rate of taxation under the new AMT rules. As well, Trusts used for investment income sprinkling amongst family members using interest-bearing loans will now have AMT (unless the Trust’s typical income sprinkling methodology is revised).
How will this affect charitable giving?
Because the new AMT calculation will include 50% of any non-refundable tax credits—down from 100% currently—philanthropic giving will have a reduced ability to reduce tax under the alternative model. This also affects donations of flow-through shares, as the deductions and credits allowed will be narrowed.
In addition, donors who make gifts of appreciated stock—which has been, and continues to be, a great way to maximize the impact of charitable donations—may now face a tax on capital gains from these securities in the AMT calculation. Whereas before there was no tax levied on these gains, the new rules call for 30% of these gains to be included in the AMT base.
Another example is employees donating stock options. While there has been a special plan where if you donate certain stock within 30 days of exercising the stock option, the entire benefit on that stock option may have been non-taxable—that may no longer be the case.
With these changes, many people earning capital gains or donating securities could find they owe much more tax in 2024 than if they had made the same filing in 2023.
If I pay AMT, is there a chance to recuperate those taxes?
Yes. The “good news” about the AMT is that it acts as an anti-deferral tax, which means it is refundable to the taxpayer in the next seven years as a credit against regular income tax. So, if you had to pay the AMT in one year, you might structure your compensation or investment income in a way that you could have a very high rate of income within the next seven years to recuperate as much AMT paid as possible. Often, high-income individuals have a certain amount of control over the types of income they receive, such as an extra bonus or salary from a corporation they control (which would help to “soak up” any AMT paid).
I have a charitable legacy gift to St. Michael’s Foundation as part of my will. Will AMT affect this planned donation?
That is wonderful. And no, the AMT will not affect charitable donations included in your will because it is not applicable in the year of death.
From a Canadian tax perspective, the year of death is very important because that is when we have a deemed realization of gain on all assets that are not left to a spouse. Many people choose to make very large donations as part of their will—both to leave a legacy, as well as to offset some of the income tax that may otherwise hit the year of death. Importantly, the AMT changes don’t affect this.
How will the changes to AMT affect my charitable giving using flow-through shares?
The use of flow-through shares has been a very important feature in the Canadian giving landscape, where it effectively lowers the cost of giving—or seen from the other perspective, it allows donors to magnify the size and impact of their donation.
When I have clients who are using flow-through shares to make personal gifts, I often look at the AMT as a goalpost, to determine how much flow-through can be used before the AMT becomes higher than the standard tax calculation.
The new rules will effectively narrow the end zone for personal giving—reducing the amount of flow-through shares that can be personally donated before the AMT kicks in.
For now, donations of flow-through shares made by corporations should not be affected by the new AMT rules, and may still be a very attractive way to make a donation.
How can you reduce being caught off guard by the AMT, and owing unexpected taxes?
In the short term, if you’re planning to make a large donation or realize a large capital gain—you may want to try to do so in 2023, before the new rules come into effect. You might also want to make payments this year on any charitable pledges you’ve made. But you will also want to have enough income this year to soak up the full tax benefit of the donations in 2023.
Another thing to consider would be to roll personally held investments into a corporation on a tax-deferred basis in 2023 (prior to the future sale of the investment). While there is a slightly higher overall tax rate associated with having a capital gain at the corporate level versus at the personal level, this will likely be lower than the taxes incurred if AMT would apply on the personal capital gain.
As of 2024, one way to avoid being surprised by the AMT is to offset any large amounts of charitable giving with increased taxable income—for example, through retirement fund withdrawals. This is also something you can do in subsequent years if you end up paying AMT, as you have seven years to recuperate those taxes. Of course, by pulling money out of your retirement fund earlier than intended you will be paying income tax sooner than you would have otherwise, so it isn’t straightforward.
If you think you might be affected by the new rules, I strongly recommend discussing your plans and options in depth with your tax and wealth advisor, and considering how the upcoming AMT changes could affect your finances and philanthropic goals.
Who should I contact at St. Michael’s Foundation about my charitable giving?
Donate to St. Michael's Foundation.