Why making a deliberate TFSA overcontribution is never a good idea

Jamie Golombek: CRA will tax any source of revenue or achieve coming up from a planned overcontribution at 100%

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A contemporary case involving an enormous overcontribution right into a tax-free financial savings account (TFSA) generated numerous attention-grabbing questions from readers about how the ensuing penalty tax works, and the way highest to reduce it. We’ll resolution a few the ones questions under, however first let’s evaluation the TFSA contribution (and overcontribution) regulations.

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The TFSA annual greenback restrict for 2023 is $6,500, however you might be able to give a contribution greater than this quantity you probably have unused TFSA contribution room carried ahead from prior years. Should you’ve by no means contributed to a TFSA sooner than, and feature been a minimum of 18 years of age and a resident of Canada since 2009, your cumulative TFSA restrict is recently $88,000.

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Any other level to remember is that for individuals who have withdrawn budget from their TFSAs, the total quantity withdrawn (this is, each your contributions and any tax-free source of revenue or enlargement) is added again for your contribution room starting the calendar 12 months after withdrawal.

Should you reduce to rubble and overcontribute, there’s a penalty tax of 1 in keeping with cent monthly for every month there’s a TFSA overcontribution. The Source of revenue Tax Act, on the other hand, lets in the Canada Earnings Company the discretion to grant reduction, and states the CRA might waive or cancel the penalty tax if the surplus arose thru “cheap error,” and is corrected by way of the person “directly.”

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The case I wrote about ultimate week concerned a taxpayer who overcontributed to his TFSA to the track of $639,308 and invested the budget into shares. He was once reassessed by way of the CRA and hit with an overcontribution tax of $6,393.08, which is one in keeping with cent of the overcontributed quantity, with regards to one month of overcontribution in 2020.

After he was once reassessed by way of the CRA and advised to right away withdraw his extra contributions, the taxpayer declined to take action, who prefer to attend till “the marketplace stepped forward.” At one level, his portfolio was once down 50 in keeping with cent, which might be about $320,000.

Many readers puzzled why the taxpayer didn’t merely withdraw the surplus contribution “in-kind,” after which stay up for the shares to rebound outdoor his TFSA. There are two most likely causes.

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The primary is if the shares throughout the TFSA bounced again, the following restoration can be tax unfastened. If, then again, the dropping shares had been withdrawn “in-kind” from the TFSA, their price for tax functions, or adjusted price base, can be set on the honest marketplace price at the date of withdrawal, or $320,000. If the shares totally recovered to $640,000, then a capital achieve of $320,000 would outcome when the shares had been offered, part of which might be taxable.

However the larger downside is {that a} withdrawal of the shares in-kind, when they’re value best $320,000, would nonetheless depart a $320,000 TFSA overcontribution, which might generate an extra penalty of 1 in keeping with cent monthly till sufficient new TFSA room is generated. Ignoring periodic inflation changes to the yearly TFSA restrict, it will take just about 50 years for sufficient TFSA room to be generated to forestall the penalty tax. If this seems like an absurd outcome, it’s. And it’s one thing I officially posed to the CRA at a convention in 2021.

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I envisioned a situation the place a taxpayer moved to Canada in, say, 2023, and opened a TFSA quickly afterwards. As a result of he was once in the past a non-resident, the taxpayer’s TFSA contribution room for 2023 was once best $6,500. Because of a false impression of the principles, the taxpayer contributed $19,500 to his TFSA and invested all of it within the stocks of 1 corporate. Prior to he had a possibility to withdraw his $13,000 overcontribution, the corporate went bankrupt and the worth of the stocks in his TFSA dropped to 0. How can the taxpayer prevent the TFSA overcontribution tax, or request a waiver of the tax, if he can now not withdraw the overcontribution? Or does he merely want to wait it out for 2 years, accruing the per month penalty tax, till new TFSA contribution room opens up?

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The CRA answered that the taxpayer on this case is not able to withdraw any quantities from their TFSA and, due to this fact, “can be not able to mitigate the tax on this way. Most effective new TFSA contribution room that turns into to be had to the person in years yet to come will serve to cut back the surplus TFSA quantity … (Since) the person is not able to withdraw any quantities from their TFSA … (the CRA) would don’t have any authority to waive or cancel the tax.”

Assuming the person doesn’t make any further contributions to his TFSA sooner than 2026 and the TFSA greenback restrict for every of 2024 and 2025 remained at $6,500, the surplus TFSA quantity can be diminished to $6,500 as of Jan. 1, 2024, and entirely eradicated as of Jan. 1, 2025. The web result’s that the person can be responsible for the one-per-cent per month tax in 2023 and 2024. The person may just resume making TFSA contributions once more in 2025.

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That is actually an absurd outcome and requires a legislative repair. Within the period in-between, a taxpayer in this sort of scenario may just observe for a remission order.

The opposite query some readers had was once whether or not it ever is smart to intentionally overcontribute to a TFSA within the hope that any penalty tax might be offset by way of the tax-free achieve within the TFSA.

For instance, let’s say Katy receives a sizzling tip a few penny inventory anticipated to double inside of a month. She’s totally maxed out her TFSA contribution room, however intentionally overcontributes $500,000 into her TFSA in Would possibly 2023, and invests all of it in that one inventory. Certain sufficient, a month later, the inventory doubles to $1 million within her TFSA. She’s more than pleased to pay a one-per-cent penalty tax of $5,000 on her $500,000 overcontribution.

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However Katy wishes to grasp there’s a unique anti-avoidance rule within the Tax Act that states that any source of revenue or achieve coming up from a planned TFSA overcontribution is thought of as to be an “merit,” and is taxed at 100 in keeping with cent. Thus, creating a planned TFSA overcontribution is rarely a good suggestion.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Property Making plans with CIBC Personal Wealth in Toronto. Jamie.Golombek@cibc.com.


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