New tax rules for high net worth individuals
By Erica Nielsen, CPA, CA 21 November 2023 6 min read
There are important changes to the Alternative Minimum Tax (AMT) coming in 2024 that high income-earning individuals should be aware of. In this article we will highlight some of the key changes that are coming and identify situations where individuals may be impacted by these changes.
What is AMT?
As its name suggests, AMT is an alternate way to calculate tax. The purpose behind this parallel tax calculation is to ensure that high income-earning individuals pay at least a minimum amount of tax when benefiting from certain deductions or credits.
The complex AMT calculation involves adjusting regular taxable income using only those deductions and exemptions permitted for AMT purposes. This adjusted taxable income (ATI) is then reduced by an AMT exemption amount and multiplied by a flat AMT tax rate. The resulting AMT can then be reduced by certain eligible tax credits. If the AMT is higher than the “regular” tax, the taxpayer must use the alternative tax calculation and pay the amount owing.
It should also be noted that AMT is not applicable in the year of death.
Can AMT be recovered?
If AMT does apply, it can typically be refunded over the next seven years. Should an individual continue to earn sufficient taxable income after paying AMT, they can generally claim the historical AMT as a credit against the taxes that would otherwise be payable in those future years. As a result, AMT is often just a prepayment of tax, assuming one continues to earn income. Any AMT that has not been refunded after seven years is generally unrecoverable, becoming a permanent tax.
What are the key changes coming in 2024?
Some of the key changes that will impact the calculation of AMT starting in 2024 include:
- Increasing the capital gains inclusion rate from 80% to 100%
- Increasing the capital gains inclusion rate on donations of publicly listed securities from 0% to 30%
- Increasing the employee stock option benefit inclusion from 80% to 100% (this effectively eliminates the stock option deduction available)
- Limiting the deduction of certain expenses (including interest and financing costs incurred to earn income from property) by 50%
- Restricting the deduction of capital losses carried forward and back to 50%
- Limiting certain non-refundable tax credits by 50% (including the donation tax credit)
- Increasing the AMT exemption amount from $40,000 to approximately $173,000 in 2024 (indexed to the bottom of the fourth tax bracket)
- Increasing the AMT rate from 15% to 20.5%
These changes apply only for the purposes of the AMT calculation. The inclusion rate for capital gains, for example, remains at 50% under the regular tax system.
Generally, the majority of the changes will result in an increased ATI for taxpayers starting in 2024. While the increase to the AMT exemption amount will help offset the increased income inclusions for lower income individuals, high-income individuals may see an increase in the impact of AMT starting in 2024.
Who might be impacted?
Below we will walk through a few situations where high-income individuals may be negatively affected by the changes that are coming to the AMT regime. The examples will compare the 20231 regular federal taxes payable to both the current (2023) AMT and new (2024) AMT.
Individuals realizing large capital gains
For regular income tax purposes, only 50% of capital gains are included in taxable income. This results in a normal federal tax rate of 16.5% on capital gains for individuals who pay tax at the top federal rate.
In 2024, the AMT rate of 20.5% is 4% higher than the top federal rate for capital gains. The overall impact is such that significant capital gains realized in 2024 may give rise to AMT.
Example 1: Large portfolio gains
Lou has an investment portfolio with accrued capital gains of $2 million. Lou has decided she wants to rebalance the portfolio to reduce her risk exposure, selling around a quarter of the investments. This would trigger $500,000 of capital gains.
If Lou chooses to rebalance her portfolio in 2023, she would trigger her tax bill sooner, but may avoid AMT. However, if she chooses to do so in 2024, she would have over $7,000 of AMT payable over and above her regular tax bill. Provided her portfolio continues to generate taxable investment income in the following years, the AMT payable may be more of a pre-payment of tax, due to the seven year AMT recovery period. If she does not have enough taxable income in future years to fully recover the AMT, any unrecovered AMT would be a permanent tax.
Individuals making significant cash donations
Starting in 2024, only 50% of charitable donation tax credits will be allowed to reduce AMT. The good news is that individuals earning only employment or rental income who make large cash donations generally should not trigger AMT. However, large cash donations made by individuals with significant tax-preferred sources of income (such as dividends or capital gains) may trigger AMT.
Example 2: Eligible dividends and cash donation
Gary receives an eligible dividend of $500,000 from his company. He decides to make a cash donation of $300,000 to his favourite charity.
For AMT purposes, dividends are not subject to the dividend gross-up and tax credit system. This will remain the same for AMT in 2024.
In this example, Gary will pay over $15,000 of AMT in 2024 where he would not have in 2023. Gary may wish to discuss with his tax advisor whether he should consider paying himself a mix of salary and dividends in 2024 to reduce the impact of AMT when he makes large donations.
Individuals donating publicly listed securities
Individuals who make in-kind donations of publicly listed securities may be more heavily impacted by the changes to the new AMT rules. Under the regular tax rules, individuals who donate publicly listed securities generally receive two tax benefits:
- They do not pay capital gains tax on the appreciation of the donated securities, and
- They receive a charitable donation receipt equal to the market value of the donated securities.
Starting in 2024, 30% of the capital gain from the donation of the securities will be included in AMT income. Currently, there is a 0% inclusion rate for AMT purposes, mirroring that of the regular tax calculation. This increase in the inclusion rate paired with the reduction of the charitable donation credit to 50% could lead to additional AMT payable on donations of publicly listed securities.
Example 3: In-kind donation of publicly listed securities
Jessica has publicly listed securities with a market value of $400,000 and a tax cost of $50,000. She decides to donate 20% ($80,000) of her shares directly to a charity and sells the remaining shares for cash.
Her donated shares have a capital gain of $70,000 and the remaining shares have a capital gain of $280,000.
For regular tax purposes, Jessica would only be taxed on 50% of the capital gain on the shares she sold for cash. For AMT purposes, in 2023 80% of the capital gain on the shares sold for cash would be included in income, compared to 100% of that gain in 2024. Additionally, in 2024, 30% of the capital gain of the donated shares would be included in income for AMT purposes and her donation tax credit is limited by 50%.
This results in Jessica paying over $10,000 in AMT in 2024. Jessica may wish to consult with her tax advisor about whether she should consider making her in-kind donation before year end to eliminate the AMT.
How can you plan ahead to minimize the impact of AMT?
Encountering an unexpected tax bill is never a fun surprise. High-income individuals who are considering incurring significant capital gains, claiming their lifetime capital gains exemption, exercising large amounts of stock options or making large cash or in-kind donations may wish to speak to their tax advisor to understand the impacts of AMT on their specific situations.
As the end of the year approaches it is a good time to determine if you will benefit from scheduling certain transactions prior to 2024 in order to minimize the impact of AMT. However, should you find yourself in a situation where you are paying AMT, ensure that you take the time to look ahead and speak with your advisor on structuring your investment income and compensation such that you can recover as much of the AMT paid as possible.
Based on 2023 personal income tax brackets, to be indexed for 2024. Except as specifically noted, tax credits, including the basic personal tax credit have been excluded from the sample calculations.
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