Taxpayer wasn’t fast enough to avoid penalty for TFSA overcontribution

The Canada Revenue Agency. Photo by BRUNSWICK NEWS ARCHIVES

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This week, for example, an individual shared with me that they were hit with $1,200 in penalty tax for overcontributing by $23,000 to their RRSP. The individual attributed their mistake to simple “human error,” in that the contributor “basically forgot” that they had contributed a lump-sum to their RRSP previously, and did so again in same calendar year. The mistake was only discovered when they were filing their 2024 tax return.

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The penalty for overcontributing to an RRSP is one per cent per month for each month the overcontribution (beyond a $2,000 allowable overage) remains in the account. Under the Income Tax Act, however, the Canada Revenue Agency (CRA) has the discretion to waive this overcontribution tax if the excess contribution occurred because of a “reasonable error” as long as “reasonable steps” were taken to eliminate the excess.

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Taxpayers who are hit with the penalty tax can apply, in writing, to the CRA for a waiver of the tax if they can demonstrate that the above two conditions have been met. Ideally, any application for a waiver should include proof that the excess contributions were withdrawn, along with any other correspondence that shows the excess contributions were due to a reasonable error.

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Be forewarned, however, that the CRA does not consider reasonable error to include receiving incorrect advice from a financial institution, misunderstanding notices sent by the CRA or posted to its website, or a lack of understanding of the law itself.

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The penalty for accidentally overcontributing to a TFSA is similar to overcontributing to an RRSP (i.e. one per cent per month of the overcontribution), but there’s no $2,000 allowance in the case of the TFSA penalty tax. To get the TFSA penalty tax waived, a taxpayer needs to establish that the overcontribution was the result of a reasonable error, and that the overcontribution was removed “without delay.”

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If the CRA refuses to waive the tax, then a taxpayer has the right to seek a judicial review of the CRA’s decision in Federal Court. A recent case, decided last month, involved a TFSA overcontribution which was ultimately removed, but apparently not fast enough for the CRA.

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The taxpayer’s troubles began in January 2021 when she contributed $29,000 to her TFSA. Unfortunately, her TFSA contribution limit for 2021 was only $11,048, resulting in an excess contribution of $17,952.

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On July 26, 2022, the CRA sent the taxpayer a notice of assessment for her TFSA indicating that she had overcontributed for the 2021 tax year, charging her $2,154 in overcontribution tax, along with a $108 penalty, and $10 in arrears interest. The taxpayer also faced $1,434 of TFSA overcontribution tax for the 2022 tax year.

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On February 13, 2023, the taxpayer withdrew her TFSA overcontribution, which had since decreased to $5,452 as of January 1, 2023, since new TFSA room of $6,000 and $6,500 opened up for 2022 and 2023 respectively ($5,452 being the original overcontribution of $17,952, less the $12,500 of new room). She also wrote to the CRA on that date asking the agency to waive the penalty tax, arguing that she was “misled” by the contribution limit indicated on her CRA’s My Account.