The Alternative Minimum Tax, or AMT, was initially proposed as a way of bringing fairness and equity to the Canadian tax system.
As one of two calculations that high-income taxpayers in Canada need to make in order to determine their annual obligation, the AMT can result in a higher-than-expected tax burden if the filer doesn’t employ certain strategies to mitigate triggering its application.
Then again, avoiding the AMT requires some understanding of how it works and that is not common knowledge.
We’re here to clarify that matter and explain what the AMT is and how it functions in the Canadian tax system.
Beyond that, we will look at what specifically triggers the AMT and what common strategies Canadian taxpayers can use to avoid triggering the AMT altogether.
What Does Alternative Minimum Tax Mean?
The AMT targets high-income taxpayers who may utilize various tax-reduction strategies to lower their annual tax obligation.
These strategies include but are not limited to tax shelters, various deductions, non-taxable capital gains, and property depreciation.
The AMT can be triggered by aspects of a taxpayer’s annual return and, when this happens, advantages that the filer expected to enjoy are eliminated partially or entirely.
In some cases, this can result in a higher-than-anticipated tax burden for the filer who expected to enjoy the benefit of the various tax reduction strategies he employed.
Reasons Behind the Tax
Established in 1986 as a way to bring fairness to the tax system, the AMT makes sure that every Canadian taxpayer pays something every year.
This was because, as can be imagined, some taxpayers were able to take advantage of a range of deductions that either drastically lowered their annual taxes or eliminated them altogether.
What does this mean for Canadian taxpayers?
In practice, the AMT translates into two separate tax calculations for high-income earners. These two methods are referred to as the “regular” and “AMT” methods respectively.
As can probably be readily determined, the taxpayer is obligated to pay the higher of the two calculations no matter which comes out on top.
Calculating the AMT
The AMT method of calculating a taxpayer’s annual obligation makes use of something called the “adjusted taxable income.” To keep it simple, a filer calculates their adjusted taxable income by taking their net taxable income and then adjusting for certain tax preference items.
Tax preference items can include capital gains, Canadian dividends, tax-shelter deductions, and others.
Your adjusted taxable income is then reduced by a $40,000 exemption and multiplied by the lowest marginal federal tax rate of 15%.
At this stage, specific non-refundable tax credits are deducted to arrive at the final AMT number. As we explained before, the taxpayer is responsible for the higher of the two amounts: The AMT or federal taxes.
On the province level, there is also a provincial AMT that must be calculated. Just like with the federal AMT, the taxpayer is responsible for the higher of the two numbers between that and the provincial tax.
Triggering the AMT
How is the AMT triggered?
Typically, AMT is triggered by a range of taxable events that could occur throughout the year. These could be something like a taxable gain or loss on an investment, such as rental properties, or carrying charges on specific types of investments.
Deductions related to capital investment depreciation such as equipment or losses in a business partnership also commonly trigger AMT.
While this doesn’t apply to most taxpayers, AMT can also be triggered by the expenses related to oil exploration and drilling in Canada or an overseas employment tax credit, among others.
In general, AMT is often activated when the taxpayer is posting too many income-tax deductions in a given year though this isn’t always the case as it can also be triggered by one-time events as well. This why the strategies for avoiding the AMT are as diverse as the taxpayers themselves.
One strategy to avoid triggering AMT is for an executive at a company to receive compensation in the form of direct income rather than in dividends.
On that note, investment portfolios geared towards dividend payments could instead try interest-based strategies instead to avoid triggering the AMT amount. There is also a credit for taxpayers that pay AMT one year but not the next.
Of course, there are also situations in which the AMT does not apply such as in the case of death or bankruptcy.
To find out if the AMT applies to your tax situation, consult with a Canadian tax expert to see what strategy best fits your specific needs.