Tax Insights: Proposed changes to the alternative minimum tax ─ How will it affect individuals and trusts?

Issue 2023-31

In brief

The 2023 federal budget announced significant changes to the alternative minimum tax (AMT) regime to better target the AMT to high‑income individuals. On August 4, 2023, the Department of Finance released draft legislative proposals to modify the AMT regime,¹ effective for taxation years beginning after 2023. The proposed changes would be the most extensive reforms to the AMT regime since it was introduced in 1986. The main proposed changes:

• increase the federal AMT rate from 15% to 20.5% and the basic exemption amount from $40,000 to the start of the second from top federal tax bracket (i.e. approximately $173,000 in 2024; to be indexed annually)
• adjust the calculation of taxable income to expand the limits on certain tax benefits, such as certain exemptions and deductions
• limit access to certain tax credits that could otherwise reduce the AMT payable

This Tax Insights provides an overview of the proposed changes to the AMT and some examples of how the proposals will affect individuals and certain trusts.²

In detail

Overview of the current AMT regime

The AMT regime involves a complex calculation that adjusts the individual’s regular taxable income by limiting access to certain exemptions and deductions that are otherwise allowed. Once the adjusted taxable income (ATI) is calculated, the ATI is reduced by the basic exemption (currently $40,000), multiplied by the AMT tax rate (currently 15%) and reduced by certain tax credits. The AMT is therefore equal to:

15% * (ATI – $40,000) – eligible non‑refundable tax credits

If the AMT calculated exceeds the regular federal income tax otherwise payable, the individual will have to pay the AMT instead of the regular federal income tax. The difference between the AMT and the regular federal income tax is considered a “temporary” refundable tax that, once paid, can be applied in the following seven years to reduce the amount of regular federal income tax that the individual would otherwise have to pay, up to the amount by which that regular tax exceeds the AMT calculated for that year.

Certain trusts are also subject to the AMT, but only graduated rate estates (an estate that is a testamentary trust for the first 36 months after the date of death) benefit from the basic exemption.

Overview of proposed changes to the AMT regime

Increasing the rate and basic exemption and limiting non-refundable tax credits

The proposed changes will:

• increase the AMT rate to 20.5% and the basic exemption amount to the start of the second from top federal tax bracket (which is expected to be approximately $173,000 in 2024)
• limit deductibility of certain eligible non‑refundable tax credits to 50% (exceptions apply) (e.g. the charitable donations tax credit is affected by this change)

If the proposed legislative amendments are enacted, the new minimum tax calculation for 2024 will be:

20.5% * (ATI – $173,000) – (50% * eligible non-refundable tax credits, with certain exceptions)

Adjusting the ATI calculation

The proposed changes will modify the ATI calculation by adjusting the inclusion rate for certain types of income and limiting or restricting access to certain deductions and expenses. Key changes follow:

• The inclusion rate for capital gains, allowable capital losses and gains from listed personal property will increase to 100% (from 80%).
• The inclusion rate for business investment losses³ will decrease to 50% (from 80%).
• The employee stock option deduction will no longer be available; this effectively increases the inclusion rate for taxable stock option benefits to 100% (from 80%).
• The capital gains inclusion rate on donations of:
  • publicly listed securities will increase to 30% (from 0%)
  • all other property will increase to 100% (from 50%)
• The deduction of certain expenses will be limited to 50% of the amount otherwise deducted for the year (this includes, among others, interest and financing costs incurred to earn property income,⁴ moving expenses, childcare expenses and the disability supports deduction).
• The deduction for non‑capital losses and limited partnership losses of other years will be limited to a maximum of 50% (from 100%).
• The inclusion rate for capital losses carried forward and back will be reduced to a maximum of 50% (from 80%).

Proposed changes affecting trusts

The draft legislative proposals:

• extend the basic exemption to qualified disability trusts⁵
• exclude certain trusts from being subject to the AMT, such as graduated rate estates and trusts that are exempt from tax under Part I of the Income Tax Act (e.g. charities)⁶

Other inter-vivos trusts will continue to remain subject to the AMT without benefiting from the basic exemption.

What remains unchanged?

The draft legislative proposals do not change many features of the current AMT regime, including the following:

• The AMT does not apply in the year an individual dies.
• The ATI includes taxable dividends at their cash value (instead of the grossed‑up amount for regular tax purposes) and fully disallows the dividend tax credit.
• The effective inclusion rate for capital gains eligible for the capital gains deduction remains 30%.
• The carry-forward period to use AMT payable to reduce regular federal income tax payable remains 7 years.

Examples of how the proposed changes affect individuals and trusts

Below are three examples of how the proposed changes to the AMT will affect certain individuals and trusts; for simplicity, only the tax credits noted in the examples are considered.

Individual disposing of capital property

This example considers an individual who:

• earns ordinary income of $250,000 (such as employment income, retirement income or interest income), and
• disposes of capital property in the year and realizes a capital gain of $1,500,000

PwC observes

Under the current rules, no AMT would be payable in this example because the regular federal income tax is higher than the AMT. However, with the proposed AMT changes, the overall federal tax payable by the individual will increase to $322,271. This example illustrates how individuals with significant capital gains may be negatively affected by the proposed AMT regime, because it effectively increases the inclusion rate for capital gains.

Individual donating capital property that is not a publicly listed security

This example considers an individual who:

• earns ordinary income of $450,000 (such as employment income, retirement income or interest income), and
• donates a capital property that is not a publicly listed security to a registered charity with an adjusted cost base of $100,000 and a fair market value of $1,000,000

PwC observes

Under the proposed AMT regime, which increases the capital gains inclusion rate for the donated capital property and the AMT tax rate (as illustrated in the first example), as well as limiting the donation tax credit to 50%, the individual will pay an overall federal tax payable of $129,123. This increases the individual’s tax payable by $79,640 (i.e. $129,123 less $49,483), which the individual will have to personally fund because no consideration was received for the donated property. Accordingly, individuals may have less incentive to make significant charitable donations (especially if the donated property has unrealized capital gains). It will take time to understand how the treatment of charitable donations under the proposed AMT regime might negatively affect the charitable sector.

Trust with interest expense paid to earn income from property

This example considers an inter‑vivos trust (that is neither excluded from AMT, nor qualifies for a basic exemption amount) that:

• received an interest‑bearing loan of $1,000,000, for which it pays interest at a 1% rate (incurring $10,000 of interest expense annually), and
• uses the above noted loan to earn interest income at a 3% rate (earning $30,000 of interest income annually)

The trustees of the trust will allocate and make payable the net income of the trust ($20,000) to the trust’s beneficiaries.

PwC observes

Under the proposals, if a trust deducts interest expense that was incurred for the purpose of earning income from property, the trust may incur AMT, regardless of the amount of net income earned by the trust. This could occur because:

• under the proposed changes, 50% of the interest expense deduction will be denied for AMT purposes
• an inter‑vivos trust does not generally benefit from the basic AMT exemption, and
• if the trustees pay all of the net income of the trust to the beneficiaries to avoid regular income tax payable, the AMT will always be a higher amount

As this example illustrates, the proposed AMT regime could affect situations where a prescribed rate loan has been made to a family trust; this will depend on decisions made by the trustees on whether to distribute to beneficiaries all of the income earned by the trust. A trust that has received a prescribed rate loan should plan for this potential AMT exposure. The trust could consider (i) not paying a portion of its net income to its beneficiaries, so that the amount retained in the trust generates regular tax equal to the AMT and the tax paid by the beneficiaries is reduced, or (ii) using capital from the trust to pay the AMT; however, these options may not be available for all trusts (depending on the facts).

The takeaway

The increased complexity of the proposed AMT regime makes it difficult to predict whether the proposed AMT regime will achieve the federal government’s goal of better targeting high-income taxpayers to ensure they pay their fair share of taxes. In particular, it appears the proposals could adversely affect many family trusts, regardless of the value in those trusts. The apparent shift in tax policy in respect of charitable giving may also reduce the amount of charitable donations made by individuals and trusts, which would affect how charities are financed.

The proposed AMT regime will present a number of challenges to taxpayers. The complexity of the AMT formula will make it difficult for individuals and trusts to identify when AMT may apply without receiving specialist tax advice. It will also be difficult for advisers to provide simple guidance, because a separate calculation of tax based on the taxpayer’s income, deductions and credits (using different rules) will be required to determine AMT. In addition, these reforms might cause AMT to apply to taxpayers in many more situations, meaning that taxpayers may not realize that they have AMT exposure until it is too late to prevent it.

<sup>1. The proposed changes to the AMT regime will affect the AMT payable in all provinces and territories, except Quebec, which has its own AMT regime. Quebec intends to implement adjustments to its AMT regime that are similar to those announced in the 2023 federal budget; however, the province has not yet finalized those adjustments.
2. The AMT does not apply to corporations.
3. An allowable business investment loss can arise when a taxpayer disposes of certain shares or debts and realizes a capital loss. If certain conditions are met, the capital loss will be deductible against any type of income for a period of 10 years (whereas capital losses are only deductible against capital gains). If this loss is not used within the 10-year period, it will be converted into a capital loss that can be carried forward indefinitely.
4. This proposed new rule will not affect other limits that apply to certain expenses under the current AMT regime. In addition, this limit will not apply to employee ownership trusts.
5. A “qualified disability trust” is a testamentary trust that can be set up for beneficiaries who are eligible for the disability tax credit if certain conditions are met.
6. Certain trusts, including spousal trusts and certain joint partner trusts and alter ego trusts, remain exempt from AMT for the year in which a deemed disposition occurs upon an individual’s death.</sup>