Tax Free Savings Accounts

On June 1st 2010 the CRA mailed out Tax-Free Savings Account (TFSA) over-contribution letters to many Canadians. Although the program is still relatively new, it has already resulted in confusion for many investors.

Contribution to the account is limited to $5,000 a year. Any income or gain earned on the investment is tax-free. Any unused amount will carry forward to the following year for future contribution. However, withdrawn amounts do not result in excess contribution room until the following year.

For example, if you are to contribute $5,000 in February and withdraw it in September, you cannot put $5,000 in your TFSA again until the subsequent calendar year. By contributing $5,000 to your account again in the same year, you are inadvertently over-contributing to your TFSA.

In order to deter investors from over-contributing, and therefore earning additional tax-free capital gains and income, the government has put penalties in place for these over-contributions.

For minor, likely accidental over-contributions the penalty stands at 1% per month of the over-contribution for each month that the TFSA is in an over-contribution position. Unlike the RRSP, there is no ‘grace amount’ that allows for excess contribution to remain in the account without penalty tax.

The CRA realized that investors were deliberately over-contributing as they were able to earn returns on their investments that exceeded the 1% penalty. Therefore, when an investor deliberately over-contributes to his or her TFSA, the penalty increases to 100% of the capital gain or income earned.

If you have accidentally over-contributed to your TFSA, options exist for you to take action against the CRA and potentially avoid paying the over-contribution penalty as the CRA can waive the 1% penalty on a case-by-case basis. If you are in this situation, contact Mark Feldstein & Associates Chartered Accountants to help you resolve your TFSA penalty tax.