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

Nary a week goes by without me hearing from a reader or client asking for guidance with an inadvertent overcontribution to a

registered retirement savings plan (RRSP)

or

tax-free savings account (TFSA)

.

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.

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.

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 Ideally, any application for a waiver should include proof that the excess contributions were withdrawn, along with any other correspondence that shows the excess contributions were due to a reasonable error.

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.

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.”

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.

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.

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.

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

.

She also explained that she has had health issues since September 2022 that prevented her from taking care of her affairs properly and that she only learned of the CRA’s TFSA assessment by consulting her file online when applying for Employment Insurance sickness benefits.

In November 2023 the CRA sent a letter to the taxpayer informing her that she had not withdrawn the excess contributions within a reasonable period of time. The letter stated that, as a result “there are no circumstances that justify the cancellation of the 2021 and 2022 excess contribution tax … (her) request is therefore denied.”

The taxpayer appealed to the CRA asking for a second review. In her request she explained that the reasons she did not quickly become aware of the July 2022 notice of assessment were that she had forgotten that she had changed her communication preferences from paper to electronic notifications, and given her lack of technological experience she had not properly linked her email address to the email notifications.

In April 2024 the CRA denied her second-level request noting that the taxpayer had been informed of the excess contributions to her TFSA on July 26, 2022, and that she did not withdraw her excess contributions until Feb. 13, 2023, calling this seven-month delay “unreasonable.” The taxpayer, however, argued that a reasonable time to correct her overcontribution ought to be measured from the time she first became aware of the situation.

Having been twice denied relief, the taxpayer sought a review in Federal Court, where the role of the judge in such cases is to determine whether the CRA’s decision not to waive the overcontribution tax was reasonable.

The judge noted that the concept of “without delay” has been defined in several prior court decisions as a period of 30 days after a taxpayer is notified of an overcontribution. Since the CRA issued its notice of assessment on July 26, 2022, the taxpayer had until August 26, 2022, to withdraw her overcontribution, which wasn’t done until Feb. 13, 2023.

In the end, the judge noted that it’s the taxpayer’s responsibility to update their contact address and communication preferences with the CRA. In this case, the taxpayer admitted that she voluntarily chose to receive her communications electronically but that she did not associate her email address with her CRA account. Despite this, the taxpayer blamed the CRA for not otherwise notifying her of the July 2022 assessment notice. As the judge wrote, “Where a taxpayer has selected the preference to be notified electronically and neglects to look at their account on a regular basis, they cannot complain that they have not read the communications sent to them in accordance with their preferences.”

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As a result, while the judge was sympathetic to the taxpayer’s situation, she concluded that the CRA’s decision not to waive the tax given the delay in withdrawing the funds from the TFSA was not unreasonable.

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

.

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