Alternative Minimum Tax and Tax Preference Items Introduction This Tax Topic will discuss the application of Alternative Minimum Tax to individuals (including trusts) in Canada. Included is a discussion of the impact of some specific tax preference items on the Alternative Minimum Tax (“AMT”) liability calculation. AMT was introduced for 1986 and subsequent tax years, to address the government concern that high income individual earners were paying little or no income tax in a particular year. There may be several reasons why a low amount of tax is payable by high income earners. These reasons include tax sheltered investments, support and maintenance payments, loss carryovers and pension plan transfers on the change of employment. Often the income, deduction or tax credit items giving rise to the lower tax and AMT liability in any given year may be explained in terms of timing differences. The Income Tax Act (the “Act") also recognizes this timing difference in the taxation of income, with the result that AMT is a refundable tax. A liability for AMT arises when the tax payable under the AMT calculation exceeds the tax payable under normal Part I rules. Where AMT is payable in a particular year because it exceeds the amount of ordinary tax otherwise payable, the excess amount may be carried forward seven years and deducted from ordinary tax, to the extent ordinary tax is greater than AMT in those seven years. Computation of AMT The calculation of AMT in section 127.52 of the Act requires a revised computation of taxable income starting with regular taxable income and adding back certain deductions, including in income other items normally excluded and adjusting for tax credits otherwise available. The end result is adjusted taxable income. An individual (other than a trust) is then entitled to a basic exemption of $40,000. Therefore, only adjusted taxable income in excess of $40,000 is subject to AMT. The adjusted taxable income for AMT purposes less the basic exemption of $40,000 is taxed at the lowest individual Federal marginal rate (15% for 2009) less the basic minimum tax credit. The calculation is compared to ordinary tax and the greater amount with surtax and provincial tax (except for Quebec) must be paid. Note that the minimum tax in respect of a taxpayer cannot be less than the tax on split income (section 120.4). The basic minimum tax credit for AMT purposes is the sum of the following tax credits which may be deducted in computing ordinary tax payable: 2 • basic personal credit • age credit • spouse or common-law partner credit (for taxpayer only) • eligible dependent credit • credit for children born in 1992 or later • infirm dependant age 18 or older credit • charitable gifts credit • medical expense credit • disability credit and caregiver credit (for taxpayer only) • tuition, education and textbook credit (for taxpayer only) • Canada employment credit • public transit credit • adoption expenses credit • child fitness tax credit • credit for interest on student loans • home renovation expenses tax credit • new home buyers’ credit • credit for EI premiums and CPP contributions and • foreign tax credit (special calculation) All other tax credits including the dividend tax credit and political donation tax credit are not available. AMT may be calculated using Canada Revenue Agency form T691. With respect to trusts, AMT is applied to the trust's income which is not paid or payable to beneficiaries. The basic exemption of $40,000 is only available to testamentary trusts and certain inter vivos trusts created before June 18, 1971. Tax Preference Items There is no general rule to determine whether AMT will be greater than ordinary tax in any particular case. However, certain types of income, deductions or tax credits are involved in the calculation of the adjusted taxable income for AMT. A discussion of the impact of several of these items follows. RRSP and RPP contributions Prior to the 1998 taxation year, ordinary and special RRSP and RPP contributions were not generally deductible in computing adjusted taxable income subject to AMT. This was considered unduly restrictive; consequently the 1998 Federal Budget included proposals to allow a deduction of all contributions to an RPP or RRSP (including rollovers of severance payments and other retiring allowances) that are deductible in computing ordinary income. The rules are effective for the 1998 and subsequent taxation years. In addition, the rules provide for a refund of AMT paid between 1994 and 1997 which was reasonably attributable to the non-deductibility of contributions made in those years (to the extent it has not already been recovered). Capital Gains and Losses For 2000 and later years, 80% of total capital gains net of capital losses are included in adjusted taxable income. The result is that capital gains alone cannot create AMT. (The 2009 AMT rate on capital gains is 80% x 15% = 12%, while the top marginal federal rate for 2009 is 50% x 29% = 14.5%) Note that where capital gains arise on gifts to qualified charities, only the taxable portion of the gain is included in the AMT base. This is true regardless of whether the gain as a result of the gift qualifies for the special inclusion rate or not. Where the capital gains exemption is available, it may be deducted for both ordinary and AMT purposes. However, in order to be deductible for AMT purposes, the capital gains exemption 3 must have been claimed for ordinary tax purposes. Accordingly, a portion of the non-taxable portion of capital gains will always be taxable for AMT purposes, even if capital gains exemption is claimed on the taxable portion. (This is the case because the capital gains deduction is expressed at the inclusion rate of 50% while the inclusion rate on capital gains for AMT purposes is 80%. As a result, 30% of the gain will, in most cases be subject to AMT.) Capital Dividends No adjustment for capital dividends is required. As is the case for ordinary tax purposes, capital dividends are not taxed for AMT purposes. Dividends Dividends from Canadian corporations are generally subject to a “gross-up” in calculating ordinary taxable income. For AMT purposes, only the actual cash amount of the dividends is included in income, however, the AMT tax calculation does not allow a dividend tax credit. The new eligible dividend rules changed the taxation of eligible dividends by increasing the gross up and increasing the dividend tax credit; however there were no changes to the calculation of AMT income for eligible dividends. As a result the top federal income tax rate on eligible dividends will be less than the AMT tax rate on dividends. This may result in AMT being applicable to individual taxpayers who receive eligible dividends. Capital Gain Reserves Capital gain reserves affect the calculation of AMT in a manner similar to the capital gains exemption. Although a reserve may be claimed for both AMT and ordinary tax purposes (reducing the amount of the capital gain reported in a particular year), for AMT purposes 80% of the entire gain reported is included in adjusted taxable income whereas for ordinary purposes only half of the gain is included in income. Conclusion Individuals who might be affected by the AMT rules should prepare minimum tax calculations as part of their tax planning each year. The actual cost of AMT is generally the time value of money, since the additional tax paid as a result of AMT can usually be carried over and deducted against regular tax payable in the seven subsequent years. 4 The Tax & Estate Planning Group at Manulife Financial write new Tax Topics on an ongoing basis. This team of accountants, lawyers and insurance professionals provide specialized information about legal issues, accounting and life insurance and their link to complex tax and estate planning solutions. Tax Topics are distributed on the understanding that Manulife Financial is not engaged in rendering legal, accounting or other professional advice. If legal or other expert assistance is required, the services of a competent professional person should be sought. Last updated: January 2010 This document is protected by copyright. Reproduction is prohibited without Manulife's written permission.