The federal government is targeting high earners with major changes to the alternative minimum tax, raising the rate to 20.5% from 15% and limiting what it calls “excessive use of tax preferences.”
Canada already has an alternative minimum tax (AMT) to limit the tax deduction available to high earners from certain incentives. The regime applies a 15% tax rate with a $40,000 exemption amount rather than using the standard progressive rate structure. The taxpayer either pays regular tax or the AMT, whichever is higher.
However, the AMT hasn’t been significantly reformed since its implementation in 1986, the budget states, and “thousands of the wealthiest Canadians still pay very little income tax.”
To address the gap, the budget proposes increasing the AMT rate to 20.5% from 15%. It would also raise the $40,000 exemption amount — which is intended to protect lower- and middle-income Canadians from paying the AMT — to the start of the fourth federal tax bracket: a more than fourfold increase to approximately $173,000 in the 2024 taxation year. The amount would be indexed to inflation.
“It’s trying to promote a sense of equity and perhaps overcoming a bit of aggressive tax planning to impose higher rates [and] make the higher income group pay at least a minimum amount of tax,” said Brian Ernewein, senior advisor with KPMG.
Government officials said the AMT currently applies to about 70,000 Canadians annually and brings in about $200 million per year. With the proposed change, it will apply to about 32,000 Canadians but bring in almost $3 billion in revenue over five years beginning in the 2024 tax year, according to estimates.
Increasing the income level required to pay the AMT “would result in a tax cut for tens of thousands of middle-class Canadians, while the AMT will more precisely target the very wealthy,” the budget states.
The reforms mean that more than 99% of the total AMT paid by individual Canadians would be paid by those who earn more than $300,000, it said; about 80% would be paid by those who earn more than $1 million.
The proposed changes take aim at deductions, credits and other tax strategies.
The budget proposes raising the AMT capital gains inclusion rate from 80% to 100%. Combined with the 20.5% rate, Ernewein said the proposal is significant.
“Considering that the maximum regular federal tax rate applying to capital gains is 16.5%, a 20.5% AMT rate translates, at the margin, to a 62% inclusion rate for capital gains,” he said.
The budget also proposed including 100% of the benefit of employee stock options in the AMT base.
Capital-loss carry-forwards and allowable business investment losses would apply at a 50% rate, and the same limitation would apply to business losses.
If a business owner made $1 million in business income this year and lost $1 million last year, for normal tax purposes they could carry over the loss and have no income.
“For AMT purposes, you’re only allowed to use one-half of the loss carryover, so you would have $500,000 of income for AMT purposes even though over two years you have zero, and if it had all happened in one year you would have zero for AMT purposes,” Ernewein said.
That is “kind of difficult to justify in policy terms,” he said.
The proposal would maintain the 30% of capital gains eligible for the lifetime capital gains exemption in the AMT base, and include 30% of capital gains of donations of publicly listed securities.
It would disallow 50% of a number of reductions, including for the CPP/QPP, childcare expenses, moving expenses and employment expenses (other than those to earn commission income).
As for tax credits, the budget proposes that only 50% of non-refundable tax credits can be used to reduce the AMT, with certain exceptions. Currently most non-refundable tax credits can be applied against the minimum.
Trusts currently exempt from the AMT will remain exempt, though the budget said the government would “continue to examine whether additional types of trusts should be exempt from the AMT.”
The carry-forward period would remain the same at seven years.
The proposed changes would come into force for the 2024 tax year.
Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth, said advisors will have to look at how high-net-worth clients are affected by the AMT.
Some clients might look at incorporating an investment portfolio and having “those investment returns earn inside a corporation where you can control the type of distributions — in terms of dividend income — that you receive on an annual basis, perhaps limiting the effect of some of the AMT preference items,” he said.
The 2022 budget said that 28% of tax filers with income above $400,000 — the top 0.5% of earners — paid an average federal income tax rate of 15% or less in 2019. More than one in 10 of those top earners paid less than 5%, according to 2019 tax returns.