TFSA simply too taxing

National Post


Tax-free savings accounts are barely 18 months old and they're already attracting the ire of thousands of Canadians who have recently received "TFSA excess" letters warning them of their overcontributions and the penalty taxes they may owe.

On June 1, the Canada Revenue Agency mailed about 72,000 overcontribution letters to TFSA holders, representing about 1.5% of the total TFSA-holder population of 4.7 million. The letters and calculations are based on information CRA received from financial institutions. The deadline to pay penalty taxes is June 30.

In the aftermath, financial institutions and advisors have been beseiged by calls from confused clients, leading to a conference call Thursday between CRA and the industry.

The fact that so many seem to have been caught by overcontribution penalties in year one of the TFSA seems odd, since the plan was intended to be simple, providing Canadians with one of the best tax-advantaged savings opportunities since the introduction of the RRSP 50 years ago.

The plans, introduced in 2009, have become extremely popular among all income brackets for their flexibility, which may have contributed to the confusion.

TFSAs allow each Canadian over age 18 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 from a TFSA, which are tax-free, increase the available TFSA contribution room - but only in the next calendar year. That rule seems to be the main source of the confusion.

Consider, for example, Julie, who contributed $5,000 to a TFSA in January 2009, but withdrew it all in July to pay for her wedding reception. In November 2009, she innocently took $5,000 from her wedding gift money and recontributed it to her TFSA. Julie inadvertently put herself in an overcontribution position since the $5,000 July withdrawal does not create further 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. Deliberate overcontributions, where taxpayers clearly attempt to put in more than their limits to take advantage of tax-free income or growth, are subject to an additional penalty of 100% of any income or gains resulting.

Rules around transfering money between one TFSA and another have also contributed to the confusion. The TFSA legislation was prescient in anticipating errors in the early days, explicitly providing the CRA with the power "to waive or cancel all or part of the overcontribution penalty if the liability arose as a consequence of a reasonable error" and TFSA holders acted "without delay" to remove the overcontributed amount.

Those affected have some options. The CRA recommends they still send in their payment for the amount of penalty tax proposed, along with the TFSA return and a letter explaining the situation by the June 30th deadline. The CRA has stated it will review on a case by case basis. If relief is granted, the CRA will return payments.

The CRA has already received about 10,000 responses to its letter from taxpayers.

Alternatively, TFSA holders can wait until they receive a Notice of Assessment, expected to be issued in August, and then either file a formal Notice of Objection or apply for administrative relief by writing to the CRA. The risk of waiting, however, is that a late-filing penalty as well as interest may be charged by the CRA.