Implemented in 1986, the Alternative Minimum Tax is often referred to as Canada's "other" tax system. An alternate method of calculating tax payable, it came into effect to guard against situations in which high earning individuals might be in a position to pay little or no tax by using certain deductions or "tax preferences" to reduce a large portion of their income.
In normal years the majority of Canadians are not subject to the AMT. In agriculture tax situations, however, the AMT most often arises when farm property such as land is sold. The impact can be substantial on retiring farmers selling their businesses and incurring sizable capital gains in a taxation year.
To minimize the tax payable, the majority of farm families in this situation look to use their lifetime $750,000 capital gains deduction as an effective long-range tax planning strategy. The deduction amount is really a misnomer since it pertains only to the taxable portion, or $375,000 at present. The other half is non-taxable in regular tax calculations. The non-taxable portion is a tax preference that is adjusted to calculate the AMT.
To calculate your AMT, begin with your regular taxable income for the year and adjust for certain tax deductions and preferences that were allowed in calculating it.
For example, with capital gains you take your regular income and add 60% of the non-taxable portion of your capital gain and subtract $40,000 to give you your net adjusted taxable income. The latter is taxed at 15% federally to arrive at the gross amount of federal tax payable.
Provincial AMT is then calculated by multiplying the federal AMT tax payable by the provincial rate. The provincial AMT rate varies by province, ranging from a low of 33.67% in Ontario to a high of 57.5% in Prince Edward Island and Nova Scotia.
In any given year, the income tax payable is the greater of regular tax or the AMT. As a credit against future regular tax, you can carry forward over seven years the amount by which the AMT exceeds the regular tax. A long-range tax plan can help in ensuring that this credit against future regular tax does not go unused. Without long-range tax planning, the consequences of the AMT can affect the after-tax dollars slated for your retirement.
Let's look at two farm families, the Smiths and the Jones's. The Smiths' normal operation averages taxable farm income of $40,000, while the Jones's average $80,000. Both families plan to disperse assets, resulting in a $750,000 capital gain. What will the AMT mean for each of them? Please see the accompanying table to find out.
Under the regular tax column, note that the amount due and payable in both family situations does not change as a result of realizing the capital gain. The capital gain deduction has effectively kept the tax payable the same. The substantial increase in tax due and payable appears in the AMT column.
What the examples of the two families show is the AMT's general effect when a large capital gain is recognized in a taxation year.
In normal years, the AMT is not a major concern, nor is it in high net income years - unless, that is, you have reduced your income by making a substantial Registered Retirement Saving Plan contribution.
(Also worth noting: several items under the regular tax column have been adjusted to calculate the AMT, though we will leave that for another article. The rates shown are approximate and Ontario based. The provincial portion of the total tax payable will vary by province or region.)
Other facts about the AMT to consider:
- It is not applied in the year of death
- The deemed capital gain on eligible capital property, such as a quota, is not subject to it
The rules specific to capital gains and the use of the capital gains deduction are complex. The purpose of this article is simply to remind farm families of the two-tax system. If you are considering business management activities that could trigger a capital gain, it's wise to have a Collins Barrow adviser and a financial planner on your management team.
Most important, give yourself time to plan since time will increase your options when it comes to minimizing the tax consequences. The tax law, as it relates to a taxable capital gain and the AMT, does have an upside: increasing the potential returns and advantages of good planning. §
John Anderson is an Agri-Business and Family Farm Succession practitioner and Kathy Byvelds, CA, is a Tax Partner in the Winchester office of Collins Barrow.