Know your TFSA limit and stay within it to stay out of CRA trouble

Jamie Golombek: Taxpayers who inadvertently overcontribute to their TFSA face a hefty penalty tax

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Canadians will soon be able to contribute another $7,000 to their tax-free savings accounts for 2024. For someone who has never contributed to a TFSA, and has been a resident of Canada and at least 18 years of age since 2009, the cumulative TFSA limit will hit $95,000.

Your personal TFSA contribution limit in any given year, however, will vary based on both prior years’ contributions as well as any withdrawals. That’s because the full amount withdrawn (both your contributions and any tax-free income or growth) is added back to your contribution room at the start of the calendar year following the withdrawal.

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It’s important to stay on top of your TFSA contribution limit lest you inadvertently overcontribute and face the overcontribution penalty tax equal to one per cent per month for each month you’re over your limit. A one per cent tax doesn’t seem like a lot, but keep in mind that the tax is one per cent per month for each month you’re over the limit until the overcontribution is withdrawn.

For example, if you accidentally overcontribute in January 2024 and don’t discover your error until January 2025, your penalty tax for 2024 would be 12 per cent of your overcontribution. You’d have to be earning at least 12 per cent on your TFSA investment to just break even after paying the penalty tax. (By the way, any income or gain arising from a deliberate TFSA overcontribution is considered to be an “advantage,” and is taxed at 100 per cent.)

Consequently, it’s best not to get into an overcontribution situation, so you really should be tracking your own TFSA limit. This is even more important for taxpayers who have multiple TFSAs, those who don’t maximize their contributions each year and, especially, those who regularly (or even occasionally) withdraw funds from their TFSA.

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Fortunately, you can check your TFSA contribution online by logging on to the Canada Revenue Agency’s online portal for individuals called My Account. But keep in mind your TFSA contribution and withdrawal information is not updated in real time and may be out of date. Check the “as of” date posted online along with your TFSA room.

If you do get assessed with a TFSA overcontribution tax, you can always ask the CRA to waive or cancel it, which the agency has the power to do if it can be established the tax arose “as a consequence of a reasonable error” and the overcontribution is withdrawn from the TFSA “without delay.” If the CRA refuses to cancel the tax, you can take the matter to federal court, where a judge will determine whether the agency’s decision not to waive the tax was reasonable.

A tax case decided last week involved someone who accidentally overcontributed to his TFSA and, as a result, was assessed the penalty tax and interest. The taxpayer had received a notice from the CRA indicating his TFSA contribution room as of Jan. 1, 2020, was “($5,000), the brackets indicating he was over the limit by that much, but he understood this to mean he could contribute another $5,000 to his TFSA. Since the contribution room for 2020 had increased to $6,000, he contributed that amount, thus inadvertently increasing his contributions to “($11,000),” or $11,000 over the limit.

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He immediately removed the excess contributions when he received the CRA’s 2020 notice of assessment of the TFSA overcontribution penalty tax and interest, and informed the CRA of such. He then requested the penalty tax and interest be waived arguing that “not having an accounting background,” he had misunderstood the use of the brackets. He argued this was an honest mistake.

The CRA declined to do so, indicating the taxpayer had previously been notified about making excess contributions, so this was not the first time he had overcontributed. The taxpayer denied having ever been notified by the CRA about a prior excess TFSA contribution, although he did admit that a “TFSA Education letter” had been posted to his CRA account on May 17, 2019. He testified he had not read it because, in his view, “it was general information not specifically directed at him.”

The taxpayer decided to appeal his TFSA assessment in court, arguing the CRA’s refusal to cancel the penalty tax and interest was unfair. Unfortunately, he chose the wrong court, mistakenly appealing to the Tax Court of Canada.

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It seems logical that if you wanted to dispute a tax assessed under the Income Tax Act, you would appeal to the Tax Court, but this is a common mistake, especially by taxpayers who decide to represent themselves in court and are not familiar with the legal process.

The section of the Income Tax Act that gives the CRA the ability to forgive the overcontribution penalty tax is part of the “Taxpayer relief provisions.” A 2014 Federal Court of Appeal decision confirmed that “the Tax Court does not have the jurisdiction to determine whether the (CRA) properly exercised (its) discretion … when deciding whether or not to waive or cancel a penalty.” Rather, this can only be challenged “by way of an application for judicial review in the Federal Court.”

This was reconfirmed in a 2019 decision, which stated the “case law is clear: if a taxpayer wants a review of the (CRA’s) decision concerning interest relief he must file an application for judicial review at the Federal Court … (the Tax Court) cannot grant the relief that the (taxpayers) are seeking.”

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The judge in the current case noted these two decisions were “sufficient to dispose of the appeal,” but he nonetheless reviewed the taxpayer’s arguments and concluded his appeal could not be allowed. “In the end, the (taxpayer) had an obligation to ensure that his contributions were within the annual contribution limit,” he said in his ruling. “Had he taken the time to track those amounts, he could have avoided the excess contributions and thus the penalties.”

As we enter a new tax year, my best TFSA advice continues to be: Know your limit and stay within it.

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto.

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