Minimum tax, also known as alternative minimum tax, pares back the tax advantages associated with some deductions, credits and tax shelters that reduce taxable income.
The minimum tax rules were designed to ensure that high income earners must pay at least a minimum. Only individuals can be subject to minimum tax, not corporations. This covers living people as well as individual, testamentary or family trusts.
It’s important to note that the minimum tax does not apply in the year a person dies. Also, individuals (other than trusts) and graduated rate estates are entitled to a basic exemption from minimum tax of $40,000.
For high-income earners, be aware of what can trigger the alternative minimum tax:
- capital gains (since only half of a capital gain is subject to taxation);
- dividends (while dividend income is grossed up to get to the taxable amount, a dividend tax credit can be claimed);
- losses and deductions (such as carrying charges) related to tax shelters and limited partnership interests;
- losses resulting from, or increased by, claiming capital cost allowance on rental properties;
- losses from resource properties;
- stock option deduction;
- deduction for employee home relocation loan;
- federal political contribution tax credit; or
- investment tax credit.
Consider some strategies to either stop minimum tax from applying or to use up a minimum tax carry-forward amount. For instance:
- Reduce or defer discretionary deductions to future years. For example, consider reducing capital cost allowance claims or RRSP deductions to increase taxable income that is subject to regular tax.
- For owner-managers active in the business of a privately owned corporation, consider taking some salary from the corporation, instead of only dividends.
- Consider adjusting your investment portfolio so that more of the investment income is comprised of interest or other income that is taxed at the full rate.
- If you’re planning to claim the capital gains exemption on the disposition of qualified property, first calculate whether minimum tax may apply, and undertake appropriate planning as needed.
If you think you may be paying the alternative minimum tax, talk to your advisor. With careful planning, the effects of minimum tax can be reduced or even avoided entirely.