ALTERNATIVE MINIMUM TAX
and TAX PREFERENCE ITEMS
Alternative Minimum Tax and Tax Preference Items
This page discusses the application of Alternative Minimum Tax (“AMT”) to individuals (including trusts) in Canada. Included is a discussion of the impact of some specific tax preference items on the AMT liability calculation.
AMT was introduced for 1986 and subsequent tax years to address government concerns that high income individual earners were paying little or no income tax in a particular year. There may be several reasons why a low amount of tax is payable by high income earners. These reasons include tax sheltered investments, support and maintenance payments, loss carryovers and pension plan transfers on the change of employment.
Often the income, deduction or tax credit items giving rise to the lower tax and AMT liability in any given year may be explained in terms of timing differences. The Income Tax Act (the “Act") recognizes this timing difference resulting in AMT being a refundable tax. A liability for AMT arises when the tax payable under the AMT calculation exceeds the tax payable under normal Part I rules. Where AMT is payable in a particular year because it exceeds the amount of ordinary tax otherwise payable, the excess amount may be carried forward seven years and deducted from ordinary tax, to the extent ordinary tax is greater than AMT in those seven years.
Computation of AMT
The calculation of AMT in section 127.52 of the Act requires a revised computation of taxable income starting with regular taxable income and adding back certain deductions, including in income other items normally excluded and adjusting for tax credits otherwise available. The end result is adjusted taxable income. An individual (other than a trust) is entitled to a basic exemption of $40,000. Therefore, only adjusted taxable income in excess of $40,000 is subject to AMT.
The adjusted taxable income for AMT purposes less the basic exemption of $40,000 is taxed at the lowest individual Federal marginal rate (15% for 2011) less the basic minimum tax credit. The calculation is compared to ordinary tax and the greater amount with surtax and provincial tax (except for Quebec) must be paid. Note that the minimum tax in respect of a taxpayer cannot be less than the tax on split income (section 120.4 of the Act). The basic minimum tax credit for AMT purposes is the sum of the following tax credits which may be deducted in computing ordinary tax payable:
Additionally, the tax credit available under subsection 119 of the Act, which is available for individuals who ceased to be resident in Canada after October 1, 1996 and disposed of certain taxable Canadian property, and the logging tax credit are also taken into account in computing the AMT for the 2009 and subsequent taxation years.
All other tax credits including the dividend tax credit and political donation tax credit are not available. AMT may be calculated using Canada Revenue Agency form T691, Alternative Minimum Tax.
With respect to trusts, AMT is applied to the trust's income that is not paid or payable to beneficiaries. The basic exemption of $40,000 is only available to testamentary trusts and certain inter vivos trusts created before June 18, 1971.
Tax Preference Items
There is no general rule to determine whether AMT will be greater than ordinary tax in any particular case. However, certain types of income, deductions or tax credits are involved in the calculation of the adjusted taxable income for AMT. A discussion of the impact of several of these items follows:
RRSP and RPP contributions
Prior to the 1998 taxation year, ordinary and special RRSP and RPP contributions were not generally deductible in computing adjusted taxable income subject to AMT. This was considered unduly restrictive; consequently, the 1998 Federal Budget included proposals to allow a deduction of all contributions to a RPP or RRSP (including rollovers of severance payments and other retiring allowances) that are deductible in computing ordinary income. The rules are effective for the 1998 and subsequent taxation years. In addition, the rules provide for a refund of AMT paid between 1994 and 1997 which was reasonably attributable to the non-deductibility of contributions made in those years (to the extent it has not already been recovered);
Capital Gains and Losses
For 2000 and later years, 80% of total capital gains net of capital losses are included in adjusted taxable income. The result is that capital gains alone cannot create AMT. (The 2011 AMT rate on capital gains is 80% x 15% = 12%, while the top marginal federal rate for 2011 is 50% x 29% = 14.5%) Note that where capital gains arise on gifts to qualified charities, only the taxable portion of the gain is included in the AMT base. This is true regardless of whether the gain, as a result of the gift, qualifies for the special inclusion rate. Where the capital gains exemption is available, it may be deducted for both ordinary and AMT purposes. However, in order to be deductible for AMT purposes, the capital gains exemption must have been claimed for ordinary tax purposes. Accordingly, a portion of the non-taxable portion of capital gains will always be taxable for AMT purposes, even if the capital gains exemption is claimed on the taxable portion (this is the case because the capital gains deduction is expressed at the inclusion rate of 50% while the inclusion rate on capital gains for AMT purposes is 80%. As a result, 30% of the gain will be, in most cases, subject to AMT.);
No adjustment for capital dividends is required. As is the case for ordinary tax purposes, capital dividends are not taxed for AMT purposes;
Dividends from Canadian corporations are generally subject to a “gross-up” in calculating ordinary taxable income. For AMT purposes, only the actual cash amount of the dividends is included in income; however, the AMT tax calculation does not allow a dividend tax credit. The new eligible dividend rules changed the taxation of eligible dividends by increasing the gross up and increasing the dividend tax credit; however, there were no changes to the calculation of AMT income for eligible dividends. As a result, the top federal income tax rate on eligible dividends is less than the AMT rate on dividends. This may result in AMT being applicable to individual taxpayers who receive eligible dividends; and
Capital Gain Reserves
Capital gain reserves affect the calculation of AMT in a manner similar to the capital gains exemption. Although a reserve may be claimed for both AMT and ordinary tax purposes (reducing the amount of the capital gain reported in a particular year), for AMT purposes 80% of the entire gain reported is included in adjusted taxable income whereas for ordinary purposes only half of the gain is included in income.
Individuals who might be affected by the AMT rules should prepare minimum tax calculations as part of their tax planning each year. The actual cost of AMT is generally the time value of money, since the additional tax paid as a result of AMT can usually be carried over and deducted against regular tax payable in the seven subsequent years.