There are many (legal) tax strategies out there to minimize tax owed to the government. For instance, say investor Derek is a BC resident and fortunate enough to have a large portfolio of dividend payers that provides his sole source of income of $70,000. According to tax tables, Derek should be able to file his income tax and pay $0 to the government due to the dividend tax credit.
Sounds like a great deal, but the government still wants their cut, which is why the Alternative Minimum Tax (AMT) was created. In this situation, both the AMT and the regular income tax must be calculated, with the higher of the two paid as income tax for the year.
How To Calculate AMT?
This is the basics of how to calculate AMT from the kpmg tax planning book for 2009,
- Calculate taxable income after all deductions for regular tax purposes.
- Add back the deductions not allowed under AMT – losses from tax shelters, losses from partnerships, interest expenses, employee relocation, 60% of amounts claimed under employee stock option deduction.
- Add 60% of the untaxed half of capital gains.
- Deduct gross up of dividends – only actual dividend amount is used for calculations, not the grossed up amount.
- Deduct $40,000 – The 2008 AMT exemption
- Multiply by 15% (federal tax) for 2008.
- Deduct Personal Credits – basic personal amount, age credit, disability, cpp contributions, EI premiums, tuition, education, medical and charitable. Do not deduct, investment tax credits, spousal amount, tuition credit transferred from a child, dividend tax credit (and more).
- If the result is higher than your federal tax calculated normally, then AMT must be paid.
- Provincial AMT is then calculated by multiplying the above AMT amount by a provincial AMT rate (varies by province).
An Example of AMT
Going back to our BC investor Derek that made $70,000 from dividends, he would actually have to pay tax. How much?
To calculate Derek’s income tax using regular rules, he would owe $0 in tax due to the dividend tax credit. However, using the AMT calculations, he would owe:
- $70,000 (dividend income) – $40,000 (amt exemption) = $30,000 x 15% = $4,500 – basic personal amount (~$1500) = $3,000 + the provincial AMT amount (up to 50% of federal amount).
In my example above, it showed an investor making $70,000 in dividends as their sole source of income. In terms of taxation, the investor went from owing $0 in tax to at least $3,000 to the federal government (not including provincial government) due to Alternative Minimum Tax. To put this in perspective though, assuming an average dividend of 4%, the portfolio size would be around $1.75 million so I’m sure the investor isn’t feeling too much pain.
There is a bright side though, because of the AMT exemption of $40,000 and basic personal amounts, most provinces will allow up to $50,000 in dividend income (as your only source) while paying very little tax (if any).
Disclaimer: I’m not a tax pro, this post should be used for informational purposes only. Please consult your tax accountant if you think that alternative minimum tax applies to you.