AMT Changes

Planning impacts of proposed legislation

Until recently, the alternative minimum tax (AMT) operated under the radar for most taxpayers. However, changes proposed in the 2023 federal budget greatly elevated awareness, although the overall effect should be to reduce the number of taxpayers exposed to AMT. The proposed AMT changes (with some modifications) were included in draft legislation released in early August by the federal government. Here’s a high-level overview of how AMT works, the changes described in the August package, and how the new rules may affect tax and estate planning in the future.

Amt Basics

Individuals are generally subject to AMT when their regular federal tax is less than the amount of tax payable under AMT. AMT currently applies at a rate of 15% of an individual’s adjusted taxable income (ATI) less a basic exemption of $40,000, which is then reduced by certain non-refundable tax credits.

An individual’s ATI is determined by increasing the individual’s taxable income (computed in the regular manner) to adjust for certain types of income (and deductions/ tax credits) that allow for preferential treatment (such as increasing the 50% inclusion rate for capital gains and disallowing tax shelter deductions). If the tax payable on the individual’s regular income is less than the tax payable under AMT, the individual must pay the AMT amount.

The amount by which an individual’s AMT exceeds regular tax payable in any particular tax year creates a tax credit, which can be carried forward for a period of seven years and may be available to reduce regular federal tax.

Rule Changes

A number of changes will be made to the AMT calculation effective in 2024 — most significantly:

• AMT rate will increase to 20.5% from 15%

• AMT exemption will increase to approximately $173,000 in 2024, from $40,000, indexed to inflation

• Capital gains inclusion rate will increase to 100% from 80% (but the inclusion rate for capital gains eligible for the capital gains exemption will continue to be 80%)

• 30% of capital gains realized on the donation of publicly traded securities will be included in income

• 50% of a variety of deductions will be disallowed

• 50% of a variety of carried-over losses (capital and non-capital) of other years will be disallowed

• 50% of non-refundable tax credits will be permitted, including the charitable tax credit

• Graduated rate estates will be exempted from AMT, and qualified disability trusts (QDTs) will be entitled to claim the increased exemption (unlike most other types of taxable trusts)

The changes will reduce the number of taxpayers who have to pay AMT (due to the increased AMT exemption), while increasing the AMT payable by certain high-income taxpayers as a result of the increased tax rate and reduced ability to take advantage of certain tax preferences, deductions, and credits.

Planning Implications

Assuming the rules are enacted as proposed, there are a number of planning considerations for individual taxpayers.

First, the new rules only take effect in 2024. Some taxpayers may consider accelerating the realization of capital gains in 2023 (to avoid the increased inclusion rate), as well as the donation of public securities. Other taxpayers may consider deferring the realization of certain income to 2024 (or later years) to benefit from the increased AMT exemption.

Taxpayers may also benefit from spreading out certain transactions over more than one taxation year. This would allow them to take advantage of the increased AMT exemption over the course of several taxation years and reduce their overall exposure to AMT. For example, instead of selling public securities with significant capital gains in 2024, the sale of shares might be structured to take place over 2024 and 2025.

Note that AMT does not apply to corporations. Some individuals may benefit from establishing a holding company to hold investment properties that may have significant capital appreciation in the future. The various tax and non-tax costs of earning income through a corporation must be weighed against the advantages of minimizing AMT exposure.

It will come as a relief to many that AMT continues not to apply to taxpayers in the year of death. Therefore, current planning strategies for minimizing/funding taxes in the final tax return will not typically need to be modified to minimize AMT. As well, capital dividends remain tax-free under the AMT regime.

Finally, family trusts will continue to be subject to AMT, but trusts other than QDTs will not qualify for any income exemption. These types of trusts may be exposed to greater AMT liability in situations where they retain income/capital gains earned on trust property and/ or have expenses that cannot be fully deducted. This may cause a review of the desirability of these trusts.

As is evident from the above discussion, the AMT proposals may be a game-changer for certain high-income taxpayers in terms of their tax and estate planning. However, any planning to minimize the effects of the proposed changes should only be undertaken with professional advice once the final AMT rules are released.

WANT

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