TFSA overcontributions explained

With the June 15th tax filing deadline for self-employed taxpayers (and their spouse or partner) just days behind us, your clients may be surprised to find that they now may be facing another upcoming deadline – June 30, 2010. That’s the due date for filing the brand new RC243, Tax Free Savings Account (TFSA) Return for 2009.

Before you panic, however, a TFSA return is only required to be filed if a TFSA holder owes taxes in respect of his or her TFSA for 2009, the most common tax related to an overcontribution.

On June 1st, the Canada Revenue Agency mailed approximately 72,000 TFSA return packages to TFSA holders, representing about 1.5% of the total TFSA holder population of 4.7 million.

The packages contained a letter, a pre-populated and pre-calculated TFSA Return indicating the taxes owing, a Transaction Summary showing TFSA contributions and withdrawals in 2009 as submitted by the holder’s various financial institutions, along with a self-addressed envelope to mail the return and payment back to the TFSA Processing Unit.

At first glance, the fact that so many seem to have been caught by overcontribution penalties in year one of the plan seems odd, since the rules appear to be relatively straightforward.

TFSAs, introduced in 2009, allow each Canadian aged 18 or over to contribute up to $5,000 annually. If you didn’t contribute last year, any unused contribution room is automatically carried forward to be used in a future year.

Any withdrawals of TFSA monies increase your available TFSA contribution room, but only beginning the following calendar year, which may be part of the source of the confusion.

Consider Julie, who contributed $5,000 to a TFSA in January 2009 but withdrew it all in July to help pay for her wedding reception. In November 2009, she innocently took $5,000 from her wedding gift money and recontributed it to her TFSA.

Unfortunately, Julie has inadvertently put herself in an overcontribution position since the $5,000 July withdrawal does not create further TFSA contribution room until 2010.

The penalty for making a non-deliberate overcontribution is severe – 1% per month for each month the overcontribution remains in the TFSA. Julie’s penalty would be $100 (i.e. 1% X 2 months X $5,000).

Deliberate overcontributions are also subject to an additional penalty of 100% of any income or gains resulting from the deliberate overcontribution.

A misunderstanding of these recontribution rules is only half the story. It seems there is also a lack of understanding about how transfers between one TFSA and another are supposed to be done.

Under the rules, if you have more than one TFSA, you can transfer funds directly from one TFSA to another TFSA (a “qualifying transfer”) without affecting your contribution room limit.

On the other hand, if you withdraw funds from one of your TFSAs on Day One and recontribute the funds withdrawn to another TFSA on Day Two, this is considered a withdrawal and contribution, not a qualifying transfer, and you could be subject to the overcontribution penalty tax.

It seems many TFSA holders attempted to skirt around the formal TFSA transfer process, which can take up to six weeks and may also involve a fee for transferring funds out of an institution’s TFSA, and were caught, innocently, by the excess contribution rules.

If you’re in this situation, and are facing penalty tax, don’t give up hope.

The TFSA legislation was prescient in anticipating innocent errors, explicitly providing the CRA with the power “to waive or cancel all or part of the (overcontribution penalty tax)…if…the liability arose as a consequence of a reasonable error” and you acted “without delay” to remove the overcontributed amount from your TFSAs.

So, what should you do if you find yourself facing penalty taxes?

If you are not contesting CRA’s proposed assessment, simply send in the penalty tax owing.

If you wish to contest the penalty tax and apply for administrative relief, the CRA recommends that you still send in your payment for the amount of penalty tax proposed along with a letter explaining the situation. These situations will be reviewed by CRA on case by case basis and it will grant administrative relief depending on the circumstances. If such relief is granted, the CRA will return your payment to you.

To date, the CRA has already received about 10,000 responses back from taxpayers.

Finally, you can choose to do nothing and wait until you receive a Notice of Assessment, which is expected to be issued in August. The risk of doing so, however, is that a late filing penalty as well as interest may be charged by the CRA if the return is received after June 30 and the penalty tax owing remains unpaid.

Once you receive your Notice of Assessment, you can either file a formal Notice of Objection or write to the CRA requesting administrative relief from the penalty tax.

Jamie Golombek

Tax & Estate

Managing Director, Tax and Estate Planning, CIBC Private Wealth Team Jamie Golombek is Managing Director, Tax and Estate Planning with CIBC in Toronto. As a member of the CIBC Private Wealth team, Jamie works closely with advisors from across CIBC to support their clients and deliver integrated financial planning and strong advisory solutions. He joined the firm in 2008 after 12 years with a global investment company, where he was involved in both internal and external consulting on all areas of taxation and estate planning. Jamie has also worked for Deloitte as a tax specialist in the Toronto office, where he specialized in both personal and corporate tax planning. Jamie is quoted frequently in the national media as an expert on taxation. He writes a weekly column called “Tax Expert,” in the National Post, has appeared as a guest on BNN, CTV News, and The National, and for several years was a regular personal finance guest on The Marilyn Denis Show. He received his B.Com. from McGill University, earned his CPA designation in Ontario and qualified as a US CPA in Illinois. He has also obtained his Certified Financial Planning (CFP) and Chartered Life Underwriting (CLU) designations. In 2023, Jamie was named a CPA Ontario Fellow. The FCPA is the highest distinction that can be bestowed upon a CPA who brings distinction to themselves and to their profession through leadership and achievement in their professional, community or personal lives. Jamie is a past chair of the Investment Funds Institute of Canada’s Tax Working Group. He is also a member of CPA Ontario, the Illinois CPA Society, the Estate Planning Council of Toronto, the Canadian Tax Foundation and the Society of Trust and Estate Practitioners. For nearly two decades, Jamie taught an MBA course in Personal Finance at the Schulich School of Business at York University in Toronto.