When wealthy clients discover their final tax liabilities for 2012, some may no doubt be surprised to find they owe Alternative Minimum Tax (AMT). Help clients avoid this shock.
Some background: Legislators introduced AMT because they saw high-income earners were paying little or no income tax. But the tax can also apply to middle-income folks. AMT runs parallel with regular income tax, requiring people pay the higher of the two amounts. It’s computed at both the federal and provincial levels, with all provinces except Quebec calculating AMT as a percentage of the federal amount.
How does it work?
The AMT calculation starts with regular taxable income and adjusts for tax-preferential items, including the non-taxable portion of capital gains, stock options benefits, Canadian dividends, and losses and deductions related to tax shelters and limited partnership interests. (Tax preferential means the tax rate is better than on normal salary and interest income.)
The result is called adjusted taxable income. From this amount, $40,000 is deducted annually to exempt lower income people and situations where there are few tax-preferential items.
The federal minimum tax itself is equal to the adjusted taxable income, minus the $40,000 exemption, multiplied by 15%. Also, clients can deduct some non-refundable credits to arrive at the minimum tax. The greater of the regular tax and the AMT is payable for the year.
Situations to watch
When a person has many tax-preferential items compared with regular income, AMT likely applies. Some examples:
- Flow-through-share deductions that are disproportionately high compared to regular taxed sources of income.
- A business owner sells a company and claims the lifetime capital gains exemption.
- A person claims significant losses and carrying charges related to tax shelter or limited partnership investments.
- Income is mostly eligible dividends (especially in 2011).
What can be done?
If AMT rears its ugly head, consider the following:
- Limit clients’ RRSP deductions to increase regular tax payable and save the deduction for a future year.
- Have your business-owner clients draw additional employment income instead of dividends.
- Restructure portfolios to earn more income at full rates (e.g. through interest).
- Limit other elective deductions such as tax depreciation in self-employed or rental businesses.
Any minimum tax in excess of the regular tax can be carried forward for up to seven years and used as a credit against future regular taxes. There is no carry-back permitted to prior years, so ensure your clients recover their minimum tax carry forwards in that period.
An AMT calculation
|Regular taxable income|
|Taxable capital gain (50%)||500,000|
|Less: capital gains exemption1||(375,000)|
|Taxable capital gain (80%)||300,000|
|Adjusted taxable income for AMT||525,000|
|Less: annual AMT exemption||(40,000)|
|Net adjusted taxable income||225,000||485,000|
|Federal tax at graduated rates||55,154|
|Federal minimum tax at 15%||72,750|
|$72,750, the greater of regular tax and AMT, is payable.2|
1 Assumes full capital gains exemption available
2 Computed before non-refundable tax credits and provincial taxes