What is Alternative Minimum Tax (AMT)?
Alternative Minimum Tax (AMT) is an alternative method to calculate the minimum amount an individual owes in taxes based on their income. It was created to establish fairness in the Canadian taxation system, meaning that higher-income earners would still need to pay their fair share of taxes net of the preferential tax treatments they may be eligible for.
Preferential tax deductions are added back to the individual’s taxpayer income to calculate their alternative minimum taxable income, and then the AMT is subtracted to determine the final taxable figure.
Why was Alternative Minimum Tax Implemented?
Alternative Minimum Tax provisions were created in 1986 to create fairness in the Canadian taxation system. Its purpose was to prevent high-income earners and trusts from paying little to no tax because of various tax deductions and incentives.
Initially, individuals were only required to calculate tax liabilities under the regular method. With the introduction of AMT, taxpayers are now required to calculate their tax liabilities using both the AMT method and the regular method.
What Preferential Tax Items Trigger AMT?
Several items may trigger AMT, namely:
- Capital gains
- Losses and deductions
- Losses and deductions related to limited partnership interests and tax shelters
- Losses from resource properties
- Stock option deductions
- Deductions for employee home relocation loans
- Federal political contribution tax credit
- Investment tax credit
When an individual can claim the items, the AMT calculation is triggered to ensure that they are paying the minimum they owe in taxes to the government.
How Does the AMT Calculation Work?
A detailed breakdown of the AMT method can be found on Form T691 for individuals or Schedule 12 for trusts.
- 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 owed in the usual way.
- If the amount at the end of Step 6 (AMT method) is greater than Step 7 (regular method), then that is the minimum amount of tax owed to the government.
By using the AMT method, the government gains assurance that individual taxpayers are still paying their fair share in taxes, both provincially and federally.
It is worth noting that if the AMT amount applies to a taxpayer, the amount paid becomes a carry-forward credit that can be used to reduce tax liabilities in the following seven years. If the carry-forward credit is unused at the end of seven years, it is wasted.
In addition, AMT is payable above the normal tax liability an individual would owe. In other words, if the regular method amount is greater than the AMT method amount, then a taxpayer only pays the tax liability.
However, if the AMT method amount is greater than the regular method, the taxpayer must pay the difference of both amounts (i.e., AMT method amount minus regular method amount) more than their tax liability.
Example of AMT
To simplify the steps above, RBC Wealth Management put together an easy formula to calculate the AMT amount. It is:
AMT Amount = A * (B – C) – D
- A = 15%
- B = The individual’s adjustable tax income
- C = $40,000, the AMT exemption amount
- D = Allowable non-refundable tax credits
Recall that you must pay the greater of the AMT method or the regular method. Applying the formula to an example, let us consider an individual with an income of $300,000 and deductions of $150,000 with an average federal tax rate of 22%.
- Subtract the deductions from the total income ($300,000 – $150,000 = $150,000)
- Assuming no other tax credits, the tax payable would be $33,000 (22% x $150,000)
- The regular method amount is, therefore, $33,000.
In contrast, the AMT amount would be calculated such that:
- Re-adjust the individual’s income to $300,000 (add back the deductions).
- Subtract $40,000, or the AMT exemption amount, from $300,000 ($260,000).
- Multiply by 15% (15% x $260,000 = $39,000).
- Subtract any allowable non-refundable tax credits, which we are assuming are $0 for our example.
- The AMT amount is, therefore, $39,000.
Here, the AMT amount is greater than the regular method amount by $6,000. Therefore, in our example, the taxpayer would need to pay $33,000 in taxes payable, in addition to $6,000 as the AMT amount.
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