NEW TRUST ALTERNATIVE MINIMUM TAX (AMT) MUST BE CONSIDERED AFTER INTRODUCTION OF NEW RULES

JANUARY 10, 2025

Beginning in 2024, new AMT rules were introduced targeting both trusts and individuals. For individuals, the legislation provides a base-level deduction from AMT income of approximately $173,000 that eliminates or eases the impact for most individuals. The government increased the exemption from $40,000 to $173,000 to avoid AMT for everyone other than high-income earners.

However, trusts are not eligible for the base-level $173,000 deduction that individuals receive, which means that many trusts will now pay AMT. In most cases we have reviewed, the trust structure still achieves the objectives, including multiplying the capital gains exemption, estate planning crystallizations, and income splitting with non-minor children; however, in some cases, the benefit has been reduced by AMT costs.

Overview of AMT for Trusts

In most cases, trusts pay no tax as the income is passed along to beneficiaries. As a result, many of the AMT adjustments are not relevant to trusts since the tax-advantaged income that sometimes causes AMT is moved to the individual.

However, investment expenses and interest are only 50% deductible under the new AMT rules creating in many cases now a tax owing by the trusts. This is particularly important for income-splitting trusts with:

-       prescribed rate loans or

-       trusts with investment advisory and management fees. 

These costs will now be only half deductible causing an AMT bill.  If, for example, a trust was formed with a $1 million loan when the prescribed rate was 2% and the funds were invested and charged an investment advisory fee of  1% then the trusts would have AMT income computed as follows:

            50% of interest expense                     $10,000

            50% of management fee                   $  5,000

                                                                        $15,000

This income would be taxed at the AMT rate of approximately 31%.

Strategic Planning Considerations

  1. Retaining Income in the Trust: Holding some income within the trust, and having the trust pay regular tax rather than distributing it will offset the AMT burden. However, this approach should be balanced against the beneficiaries’ marginal tax rates, as holding income within the trust may impact tax efficiency.

  2. Reconsidering Investment Income Types: Shifting investment strategies to favor dividend or interest income rather than capital gains may provide some AMT relief. This shift, however, should consider broader investment goals and risk tolerance, as non-tax-related factors can influence the long-term suitability of this approach.

  3. Reduced Tax Savings in Income-Splitting Trusts: Due to the AMT changes, income-splitting trusts now offer reduced tax savings compared to previous years. This shift has made income-splitting trusts less advantageous under the current AMT regime. The benefit of having this trust should be reviewed annually.

Conclusion

The 2024 AMT updates for Canadian trusts underscore the importance of proactive tax planning. As income types and distribution strategies significantly affect the AMT burden, trustees and beneficiaries should stay informed and work with financial advisors to tailor their approach. Please reach out if you have any questions.