When the Government of Canada introduced the Tax Free Savings Account (TFSA)
in 2009, the response was positive. Although contributions to a
TFSA are not deductible for income tax purposes, the income
generated in the account – such as interest and capital gains
– is generally tax-free. True to its name, the TFSA is a
vehicle that lets you invest your money tax-free during your
lifetime. As well, the notion that the TFSA can operate like a
"savings account" can be appealing, as it appears to
offer the flexibility of making contributions and withdrawals.
Unfortunately, appearances can be deceptive. While the TFSA is a
tax-saving vehicle, one must exercise diligent care where there is
a series of withdrawals and contributions. A penalty on excessive
contributions applies if an "excess TFSA amount" existed
at any time in a month, and equals 1% of such amount in that month.
The 1% tax continues to apply for each month that the excess amount
remains in the TFSA.
Consider John's situation. He contributed $5,500 (the annual
limit) to his TFSA in January 2013, withdrew $4,000 in mid-March,
and re-contributed $4,000 in late March. Meanwhile, his wife Molly
also contributed $5,500 in January, and contributed another $4,000
in mid-March and withdrew $4,000 in late March. John was convinced
that he was compliant, and suspected that his wife had gone offside
by over-contributing. In June 2014, John and Molly received their
2013 assessment notices with two surprises:
Both were assessed penalties;
Molly's penalty was only $40, but John's was $400!
The common misconception lies in the confusing definition of
"excess TFSA amount". In simple terms, it equals total
contributions minus the $5,500 limit. Total contributions include
amounts contributed at any time during the year –
even after first withdrawing an amount. However, only withdrawals
made after contributing more than the $5,500 limit reduces
the excess amount. This is why Molly's entire $4,000 withdrawal
qualified, while none of John's did. Therefore, John ended up
with an excess TFSA amount of $4,000 for 10 months, resulting in a
$400 penalty ($4,000 x 1% x 10 months), while Molly's was only
$40 ($4,000 x 1% x 1 month). The logic employed here may seem
counter-intuitive, but taxation is rarely designed for clarity.
For any year in which tax is payable on an excess TFSA amount,
you must complete and file Form RC243 "Tax-Free Savings
Account (TFSA) Return", along with accompanying schedules.
Under proposed changes, a TFSA return must be completed and filed
by June 30 of the year following the calendar year in which the
over-contribution happened. If the return is filed after the due
date, a late-filing penalty will be charged.
Amidst the confusion surrounding the TFSA rules, the
government's message is clear in at least one area: Contribute,
but with caution. For this reason, individuals are encouraged to
consult their tax advisors on their TFSA matters.
TFSA is a great way for Canadian residents to invest money
As of January 1, 2013, you can contribute up to $5,500
annually to a TFSA.
Unused TFSA contribution room is carried forward and
accumulates in future years.
Withdrawals from a TFSA are tax-free.
Full amount of withdrawals can be put back into the TFSA in
Re-contributing in the same year may result in an
over-contribution amount and a penalty tax.
Charles Fu is the Senior Tax Manager at Sloan Partners. Contact
Charles today for an analysis of your family's tax savings
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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