Significant changes were introduced to the alternative minimum tax (“AMT”) regime effective for the 2024 taxation year, impacting many high-income individuals and certain trusts that may not have been subject to AMT prior to 2024. The updated framework increased the federal AMT rate to 20.5% and broadened the AMT base, particularly in situations involving tax-preferred income, deductions, credits, and exemptions that would otherwise receive favourable treatment under the regular tax system. The AMT exemption threshold for individuals was also increased in order to limit the application of AMT to those in the higher personal tax brackets. The various provinces have separate AMT frameworks that generally parallel the federal rules.
The AMT regime is a parallel tax calculation in which taxable income is recomputed using a broader base that allows fewer deductions and imposes restrictions on credits as compared to the regular tax system. You pay the higher of this alternative calculation or regular tax with the excess (AMT) becoming a credit that is carried forward and may be used to reduce regular tax within a seven-year carryforward period.
AMT can be material in a year that a business is sold when significant capital gains are realized, particularly where the lifetime capital gains exemption (“LCGE”) is claimed. For AMT purposes, 100% of capital gains are included, compared with 50% under regular tax. As a result, AMT may apply even when regular tax is largely offset or reduced to nil by the LCGE. AMT exposure may be increased when additional tax-preferred items arise in the year of sale. Common examples include large charitable donations, interest and financing costs to earn investment income, investment management fees and losses carry-forward.
We generally recommend preparing tax projections that incorporate an AMT estimate for the year of the sale and extend this through the seven-year carryforward period based on estimated levels and composition of income in those years. This identifies the amount of potential AMT in the year of sale and provides an indication of whether the eventual recovery of AMT is realistic based on projected post-sale income.
In analyzing the prospects for recovering AMT over a period of time, consideration should be given to various discretionary income sources, such as structuring a portion of the sale proceeds on a deferred basis in order to utilize a capital gains reserve, considering strategies to generate interest income, managing salary levels and potentially drawing on RRSP’s. In addition, managing the timing of discretionary deductions and credits, such as RRSP deductions and charitable donations may facilitate the recovery of AMT. In many cases, while the vendor may have plans to make significant charitable donations after the sale of a business, this may be counterproductive to the recovery of AMT, so consideration might be given to deferring these plans.
If the analysis suggests there is a risk that a significant portion of AMT may not be recoverable, planning at the sale stage to minimize or avoid the initial instance of AMT may be possible. This may impact some details of the sale transaction, so it is strongly recommended that this analysis and discussion be considered early in the process, so as to avoid surprises for the buyer side that could delay or derail the sale closing.
Proactive tax planning before a sale is essential to manage AMT implications. Structuring the sale to manage and mitigate tax liabilities and allow for a more effective recovery of AMT during the carryforward period is key to achieving one’s goals on an exit. Connect with your Welch LLP advisor to develop a plan that aligns your timing, deal structure, and post-sale income strategy with AMT efficiency in mind.
