Special Year End Personal Tax Planning Considerations in 2024 – Changes to the Capital Gains Inclusion Rate and Update on Alternative Minimum Tax (“AMT”):

Dropping temperatures and shorter daylight are a reminder that another year is coming to an end. Following recent trends, 2024 has been another turbulent year in Canadian tax, with fundamental changes seemingly introduced on a whim.   

The most notable update that requires careful consideration when thinking of 2024 year-end planning are the proposed increase to the capital gains inclusion rate. When planning for higher income individuals, it is important to incorporate recent revisions to the AMT that were discussed is last year’s year end planning article.     

Change to capital gains inclusion rate: 

We wrote here about the proposed increase to the capital gains inclusion rate from 50% (“low rate capital gains”) to 66.67% (“high rate capital gains”) when it was first announced in the 2024 budget. The increase is applicable to dispositions on or after June 25, 2024 that exceed a $250K annual threshold available only to individuals.  

Although draft legislation is now available, the rules have not yet been enacted, and due to the current political atmosphere, uncertainty remains when, or even if, the rules as drafted will become law.   While the ambiguity presents a challenge for year-end tax planning, it is prudent to consider the proposals as they carry significant implications and are likely to eventually be implemented applicable retroactive to June 25, 2024.

Triggering capital losses: 

Tax loss selling is a typical year-end tax planning consideration that involves selling non-registered “underwater” investments in order to trigger capital losses before the end of the year. Triggering capital losses before year end may reduce current year taxes, or can be carried back to any of the previous three tax years to offset capital gains in a previous period, which can result in a refund of previously paid taxes.       

When undertaking this strategy, it is always important to ensure the planning is not frustrated by the “superficial loss” rules which would cause the loss being sought to be denied.  The superficial loss rules are triggered when a taxpayer and/or an “affiliated person” (i.e. a spouse/partner, an entity controlled by a taxpayer or their spouse/partner; or a registered accounts of the taxpayer or spouse/partner) repurchase and own the same investment within 30 days before or after the disposition.

Since there are different capital gains inclusion rates for the 2024 calendar year, it is particularly important to understand how losses that are triggered will be applied against capital gains with different inclusion rates.  Although the capital loss application ordering rules can be formulaically complicated, generally capital losses will first be applied to reduce high rate capital gains in priority to lower 50% inclusion rate capital gains.    

Accordingly, taxpayers with high rate gains from dispositions over $250K in the second period of 2024 (i.e. after June 25, 2024) will achieve greater tax savings from triggered losses. Although taxpayers with capital gains subject to the lower 50% inclusion rate may also consider triggering losses to reduce their current tax bill, consideration should be given to deferring recognition of the losses if high rate capital gains are expected in the near future.

Loss carryover balances from other tax years will also be adjusted to reflect the capital gain inclusion rate of the gain to which the losses are applied. Accordingly, when considering whether to apply net capital losses from prior years in the current year, or carrying back a current year loss, consideration should be given to whether it may be more beneficial to carry forward the losses to a future year if high rate capital gains are expected in the near future.  

Triggering capital gains: 

Traditionally, year-end tax planning focuses on triggering losses while deferring realizing capital gains to future years whenever possible to delay tax.    

While this strategy may still be highly relevant for many taxpayers under the new capital gains regime, the approach may need to be rethought for taxpayers expecting to have gains in excess of the $250K threshold limit in future years.  While it may not be possible or practical in all cases, consideration should be given to whether capital gains should be crystallized annually up to the taxpayer’s $250K annual threshold since unused limit will not be carried over to increase future limits when capital gains exceed the $250K threshold in a particular year.    

Capital gains reserves

When a portion of proceeds from the sale of a property are not received until the year after sale, a reasonable reserve may be eligible to be claimed, allowing a portion of the capital gain to be deferred and included in income over a maximum period of five years. The deferred amounts are considered included in income in future years on the first day of the taxation year. 

Accordingly, capital gains reserve claimed in prior years will be included in 2024 income on January 1, 2024 (i.e. prior to June 25, 2024) and therefore subject to the 50% inclusion rate.  However, capital gains reserve claimed in 2024 will be brought into income in future years and will be subject to the $250K limit.   

Accordingly, reserves should be claimed strategically to ensure deferring capital gains to future years does not result in a higher inclusion rate. Similarly, reserves can be used to defer the inclusion of gains that would otherwise exceed the taxpayer’s $250K threshold in the year of disposition, to a future year where the gain may fall under the low inclusion rate threshold.     

Capital gains inclusion rate and AMT: 

In last year’s Special Year End tax planning considerations for 2024, we discussed the proposed changes to the AMT regime that became effective for individual taxpayers on January 1, 2024.   

As a reminder, AMT is an alternative calculation of a taxpayer’s income tax liability which takes place in the background of each individual’s personal tax return calculation.  A taxpayer’s overall personal tax liability is determined to be the greater of the regular tax payable and the calculated AMT.   Although the AMT is intended to be a “temporary” tax with carryforward credit available for seven years to reduce future tax liabilities where regular tax exceeds the AMT, in situations where the carryforward balance cannot be fully claimed the AMT can become a permanent tax cost.

Due to changes that became effective January 1, 2024, AMT can apply in many more situations and may also be more difficult to recover in the carryover period for higher income taxpayers.   In particular, individuals reporting significant capital gains at the 50% inclusion rate and/or claiming significant tax deductions and credits, such as losses from other years and donations may be surprised to find they owe AMT due to the new rules.  

AMT may be a particular concern for the 2024 calendar year if significant capital gains were triggered prior to June 25, 2024 in preparation for the change in capital gains inclusion rate, or if efforts to rebalance portfolios in light of the new AMT rules resulted in significant dispositions during the year. 

Ironically, the proposed increase to capital gains inclusion rates for regular tax purposes may alleviate AMT concern for some high income taxpayers with large capital gains in a year subject to the higher inclusion rates for ordinary tax purposes.  Nevertheless, AMT should still be analyzed for most high income individuals as it can be triggered by multiple factors acting in unison.   

Proposed partial AMT relief for donations: 

With planning that may have been done in preparation for incoming capital gains rate changes, taxpayers may be considering making donations before the end of the year to alleviate tax burdens.  However, high income taxpayers should be particularly aware of changes to AMT when making significant donations of publicly traded securities and/or claiming losses to avoid potential surprises at tax time. 

Although the donation credit inclusion rate has been increased to 80% from the initially proposed 50% inclusion rate under the new AMT rules, since the full donation credit is not allowed as it was under the old AMT regime, large donations claimed in a year, particularly in combination with other AMT adjustments, could result in an AMT liability.

Furthermore, since gains on gifts in kind of publicly traded securities remain fully exempt from capital gains tax for regular tax purposes (Note: The exempt gains on such gifts are also not counted toward a taxpayer’s $250K annual exemption limit for the increased capital gains inclusion rate), but are now subject to a 30% inclusion rate for AMT, donations of publicly traded securities with significant accrued gains are likely to trigger AMT for higher taxpayers due to the combined effect of AMT adjustments for donations and the exempt gains.

Accordingly, taxpayers expecting to reduce their tax liability by donating public securities to benefit from the 0% capital gains inclusion rate and donation tax credit should analyze their AMT exposure.   

In conclusion, due to the fast changing tax landscape, it is particularly important for high income taxpayers to contemplate whether any adjustments to tax planning is necessary to avoid surprises.   Beyond the immediate end of year planning for 2024, a number of recent tax changes may require revisiting long term tax and estate planning strategies to ensure they remain relevant and efficient.   

While this article focuses on select personal tax changes in the context of year-end tax planning, it should not be regarded as a comprehensive discussion of recent tax changes and/or proposals.  As well, recent changes can have significant implications to other taxpayers, such as corporations, trusts, or partnerships.   Please be in touch with your Shimmerman Penn LLP representative to discuss how the changing tax landscape might impact your situation and obtain specific tax advice prior to taking any action.