On June 20, 2024, Bill C-69 implemented a number of changes to the Alternative Minimum Tax (“AMT”) regime. AMT is a parallel tax calculation which was originally introduced to ensure that individuals and trusts that benefit from significant tax exemptions, deductions and tax credits would have to pay a certain minimum amount of tax. AMT paid for a year is carried forward and can be refunded as a credit against taxes otherwise payable over the following seven years.
The purpose of this article is to discuss a particular new AMT provision which may have a significant impact on a very common type of tax planning strategy where a trust may hold marketable securities, often for the benefit of lower-income beneficiaries such as children or grandchildren of the trustee(s). This type of planning is often referred as “prescribed rate loan” planning.
Generally, a prescribed rate loan arrangement is established by having a high-income family member loan funds to a trust at an interest rate that is fixed at the CRA prescribed rate at the time the loan is made. The proceeds of the loan are then used to invest in marketable securities, with the resulting income (i.e., dividends, interest and/or capital gains) net of expenses being distributed to lower-income beneficiaries, who might pay little or no income tax.
Generally, the deductible expenses under a prescribed rate loan arrangement include loan interest expense and investment management fees. Although the loan interest expense paid by the trust is included in the taxable income of the lender, this strategy is intended to reduce the family’s overall tax liability.
Prior to the new AMT legislation, as long as the net income of the trust was fully distributed to beneficiaries, the trust would have no tax owing as these distributions are deductible from the trust’s taxable income.
However, beginning in 2024, the trust’s deduction of interest expense will be limited to 50% for AMT purposes. In addition, on August 12, 2024, the Department of Finance released draft legislation which will also limit the deduction of investment management fees to 50% for AMT purposes.
The federal AMT tax rate is now 20.5% for 2024. Accordingly, if a trust deducts interest expense and investment management fees of $10,000 and fully distributes the net income to beneficiaries, it will still have a federal tax balance owing of $1,025 (i.e., $10,000 x 50% x 20.5%).
Provincial AMT is also calculated as a percentage of the federal AMT. For Ontario residents, the provincial AMT rate is currently 33.67% of the federal AMT. However, the October 30, 2024 Ontario Fall Statement proposed to lower this rate to 24.63% beginning in 2024. Therefore, an additional provincial AMT of $252 ($1,025 x 24.63%) would be payable by the trust for 2024.
While the AMT can be refunded to the trust in subsequent years where regular tax exceeds AMT, since the nature of these trusts is generally to distribute all income to beneficiaries, it is likely that AMT could become a permanent cost with little likelihood of recovery in the seven-year carry forward period.
In order to avoid AMT, consideration could be given to leaving some income in the trust to generate regular tax and reduce the impact of AMT. However, as the income of a family trust is taxed at the highest marginal tax rate (i.e., 53.53% in Ontario), this strategy may also reduce the overall tax savings benefit of the prescribed rate loan trust structure.
Therefore, it appears that for 2024 and going forward, most trusts that earn investment income from portfolios of marketable securities will have a tax balance payable. Note that this may also include any other trust that incurs interest expense and/or investment management fees where the trust received investment capital from sources other than a prescribed rate loan such as an inheritance or proceeds from the sale of a corporation.
For 2024, the tax payment will be due on or before the T3 Trust Return filing deadline of March 31, 2025.
For further guidance on the impact of this and other AMT changes to your current situation, please contact your Welch LLP advisor.
