Capital Gains, Charitable Acts, and the New Alternative Minimum Tax

Q4 | December 2023

Topic: Tax Planning

Dianne C. White CPA, CA, CFP, TEP

December 8, 2023

Image used with permission: designer491


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Capital Gains, Charitable Acts, and the New Alternative Minimum Tax

Q4 | December 2023

If you regularly make charitable donations or perhaps sit on the board of a charitable organization, you might be wondering what all the hubbub regarding the new Alternative Minimum Tax (AMT) is about.

Recently, there have been a host of articles warning about the potential chilling impact the new AMT will have on charitable giving. The gist of the concern is that high net-worth/high income individuals who are philanthropic will lose the historic benefit of their charitable contributions and  end up paying more in taxes, which might discourage large donations. Of course, tax savings aren’t the reason to give to charities. However, there is often donation planning around a one-time financial event – like the sale of a business or sale of real estate and the new AMT rules could affect this planning. After crunching some numbers, it seems that certain circumstances are most likely to trigger the new AMT. These circumstances would include large capital gains, large donations of securities in-kind, and the combination of significant tax preferred income with large donations. The good news for Nexus clients is that most won’t be affected by the new rules.

What is AMT?

AMT is a parallel tax calculation that allows fewer deductions, exemptions and tax credits than the regular income tax rules. The calculation applies a flat tax rate instead of progressive tax brackets. The idea is that every individual needs to pay a certain minimum amount of tax each year so you must pay the higher of regular tax or AMT. If you do end up paying AMT because it is higher than your regular tax calculation, that excess tax can be recovered. The amount of AMT that is over the regular tax can be carried forward for seven years and offset against any future regular tax.

What is the difference between the old AMT and new AMT?

There have been a number of changes to the AMT rules, but these are the four most consequential that will increase income captured in the new AMT calculation:

  1. 100% inclusion rate for capital gains (from 80%)
  2. 30% of capital gains on donations of publicly listed securities (from 0%)
  3. Only 50% of the tax credits, including charitable donation credits, will be allowed.
  4. 50% of interest expenses and loss carryforwards are allowed.

A few other items to note: the flat AMT tax rate will be increasing from 15% to 20.5% but the basic AMT exemption is increasing from $40,000 to $173,000. Also, for the treatment of dividends, it is the same for the new AMT calculation as it was for the old, and will continue to use the actual amount of dividends received, rather than the grossed-up taxable dividend amount used in the regular tax calculations. The dividend tax credit is fully disallowed.

Who will be impacted by the new AMT?

The new AMT is focused on tax-preferred sources of income and deductions. If your adjusted income is below the $173,000 exemption, you won’t be affected. The new AMT calculation also won’t affect those high-income earners whose earnings mostly come from employment income, significant pension, interest and/or RRIF income. A typical Nexus client probably falls into this category, where they are earning enough income and paying enough tax at regular rates so that they will unlikely trigger the new AMT.

So, when is it likely to apply?

Taxpayers are most likely to be caught in the new rules in the following circumstances:

  • If you are triggering capital gains at the top marginal tax rate then this will likely give rise to AMT under the new rules. This is because the most significant changes to the new AMT rules concern the treatment of capital gains. Under the regular tax system, only 50% of capital gains are included in income, but now will be adjusted to 100% under the new rules.
  • If you are making a large donation-in-kind of securities from your portfolio – the dollar value of which is up to the limit of 75% of your taxable income in one year – then this will likely give rise to AMT under the new rules. This is because the new AMT rules require 30% of the capital gain on the donated securities to be included whereas under the regular tax system, none of the gain is included.
  • Finally, if you have a combination of significant tax preferred income – like capital gains mentioned and/or dividends – and you are making a large charitable donation, you will likely be caught by the new AMT rules.

Let’s look at one example. If you have $1m in dividend income from investments and you are making a large donation of stocks from your portfolio of $750,000, where the capital gain on the donated stocks is equal to the value of the donation, you will be paying about $90,000 in additional Federal tax as a result of the new AMT calculations.

The circumstances identified center around individuals solely receiving tax-preferred sources of income. If you were to introduce meaningful income taxable at regular rates into these situations, the impact of AMT could likely be eliminated.

If the new AMT applies to you, it’s important to determine if you will be able to use the carry-forward feature to offset regular tax. If you are triggering AMT due to a one-time financial event, it is more likely that any AMT triggered can be used to offset regular tax in future years. If, however, most of your income is generated from tax-preferred sources like dividends and capitals gains, then the AMT may not get recouped. If you have the flexibility to accelerate your donation to 2023 instead of waiting until 2024, you should consider doing this. There are vehicles like Donor Advised Funds that allow you to make a large-scale donation in one year to get the donation tax credit but then spread your giving out to charities of your choice over multiple years.

Ultimately, if you find yourself in one of the above situations, careful planning is required and you should get some advice regarding your specific situation. Nexus can help!

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