As Canadian residents, it is no secret that we pay a significant amount of tax, in many different forms. It could be in the form of income tax, sales tax, property tax, capital gains tax, etc. Some people will be subject to an additional tax called Alternative Minimum Tax.
No matter what tax it is, most people want to pay as little as possible. There are some legal ways to reduce the tax burden through tax deferral and savvy tax planning. However, there will almost always be some tax to pay. The worst thing is when the tax payable comes as a surprise. Unfortunately, alternative minimum tax often becomes a surprise to those who are subject to it.
This week we want to take a closer look at what Alternative Minimum Tax (AMT) is. We also want to look at how it is calculated and who is subject to it.
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What is Alternative Minimum Tax (AMT)
The alternative minimum tax (AMT) was implemented in 1986. It was established to create fairness between income earners at different taxation levels. Meaning, high-income earners still needed to pay their fair share of taxes, net of the preferential tax treatments they may be eligible for. It is essentially an alternative method to calculate the minimum amount of taxes owed based on income.
In simple terms, preferential tax deductions are added back to the taxpayer’s income to calculate their AMT income. Then the AMT is subtracted to determine the final taxable figure. This begs the question of what preferential tax treatments are being referenced? The following is a list of items that may trigger AMT:
- You reported a taxable capital gain
Or you claimed any of the following:
- A loss resulting from or increased by, claiming capital cost allowance on rental properties
- A loss from a limited partnership that is a tax shelter
- Most carrying charges on certain investments
- A loss from resource properties resulting from or increased by claiming a depletion allowance, exploration expenses, development expenses, or Canadian oil and gas property expenses
- A deduction on line 24900 for security options
- A federal political contribution tax credit on line 41000
- An investment tax credit on line 41200
- A labor-sponsored funds tax credit on line 41400
- A federal dividend tax credit on line 40425
If a taxpayer is eligible and claims one or more of the items above, the AMT calculation is triggered. However, just because the calculation is triggered doesn’t mean AMT is payable. The most common source of AMT is for people who claim the Lifetime Capital Gains Exemption.
If you claimed one of the above, you or your accountant (it should probably be an accountant), will have to complete CRA Form T691 – Alternative Minimum Tax. The AMT calculation can get quite complex and there are a lot of things that go into it. If you read through the CRA Form T691, you get a detailed breakdown of exactly how it is calculated.
However, to try and simplify it the Corporate Finance Institute broke it down into 8 steps:
- Calculate taxable income under the regular method, which considers preferential tax deductions and credits. It is the graduated tax system in Canada.
- Add back preferential tax items, such as capital gains, to establish an individual’s minimum tax amount.
- Add back 30% of capital gains (which means 80% of capital gains will now be taxable, instead of the normal 50%) for minimum tax calculations.
- Deduct the dividend gross-up which means the actual amount of dividends received during the tax year are subject to minimum tax calculations.
- Deduct $40,000, which is the basic exemption amount for the AMT method.
- Deduct personal credits
- Calculate federal income tax owned in the usual way.
- If the amount at the end of step 6 is greater than step 7, then that is the amount of tax owed to the government.
They also present a simple formula:
AMT amount = 15% * (Adj tax income – $40k) – Allowable non-refundable tax credits.
If you find yourself in a situation where you have to pay AMT there is no need to worry. In fact, you can view it as a pre-payment of tax. How so? Well, over the next 7 years, you can recover this amount paid against your regular income tax.
This means that you will have to have some form of taxable income in the 7 years following the payment of AMT. If there is not enough taxable income over those 7 years to recoup the AMT paid, that credit will be lost.
Being subject to Alternative Minimum Tax is the reality for most farmers at some point in their lives. If you think you might be subject to Alternative Minimum Tax in the future and want to do some planning, contact us. We would love hear about your situation and look forward to help you achieve the financial goals you have set out.