No one enjoys a nasty surprise when preparing their tax return. Unfortunately, Alternative Minimum Tax (AMT) has the potential to be exactly that.
AMT was enacted in 1982 to ensure a minimum amount of tax was paid on income subject to preferential tax treatment. Some common types of income and deductions that can result in AMT include capital gains and losses, certain partnership losses, security option deductions and dividends—all of which enjoy preferential tax treatment.
AMT is calculated by adjusting taxable income for items that received preferential tax treatment, subtracting a basic exemption of $40,000, and then multiplying the adjusted taxable income by the federal AMT rate of 15%. AMT needs to be paid when this amount exceeds the taxes payable under normal tax rules. Provincial AMT rates vary, but the calculation of the tax base is similar. In Ontario, provincial AMT is calculated as 33.67% of the Federal AMT.
A taxpayer disposed of shares in their Qualified Small Business Corporation. The resulting $848,252 from the share sale received preferential tax treatment as it was exempt from tax under the lifetime capital gains exemption. The taxpayer had no other income in 2018.
Under ordinary tax rules, this individual’s taxable income would be $Nil—because the capital gain is fully sheltered by the capital gains exemption—resulting in no taxes.
AMT was introduced to ensure a minimum tax was paid in situations like this. Under the AMT calculation, 30% of the capital gains are added back into taxable income.
To calculate this individual’s AMT, we start with the taxable income under ordinary rules of $Nil and add back 30% of the gain for an adjusted taxable income of $254,475. After deducting the $40,000 AMT exemption, we arrive at a taxable income of $214,475. Multiplying this by the federal AMT rate of 15%, we arrive at a federal AMT liability of approximately $32,200. Since the AMT liability of $32,200 is higher than the ordinary taxes payable of $0, AMT applies. The provincial portion of this liability in Ontario would be approximately $10,850.
Fortunately, non-refundable tax credits that reduce ordinary taxes help reduce the AMT liability as well, and any tax paid under AMT can be recovered as tax credits over the subsequent seven years if taxes payable under AMT are less than ordinary taxes payable.
Planning opportunities are available to limit AMT and ensure the recoverability of any AMT previously paid. Contact S+C Partners to help determine the best way to prepare for AMT and ensure that the only surprise you receive at tax time is how much a little planning can save you!