TFSA Over-Contributions may be Over-Penalized

Update:  I've now checked the TFSA tax calculation for 4 people and only one was incorrect according to CRA's rules.

One Canadian who goes by the handle Ref seems to have discovered a bug in CRA’s calculations of TFSA over-contribution taxes. From Ref’s calculations, it seems that CRA did not give him proper credit for removing excess TFSA contributions and continued applying the 1% tax each month even after the excess was removed. It's not clear how widespread this problem is.

The confusion many people are having with Tax-Free Savings Accounts (TFSAs) is that if you make a withdrawal, you can put the money back, but not until the next year. CRA hits you with a 1% tax each month on any excess amount in your TFSA. But, CRA is supposed to stop charging the 1% tax after the excess contribution is withdrawn according to their RC243-SCH-A form for excess TFSA amounts.

Let’s try a simple example. Sally heard great things about TFSAs and decided to open an account and make a contribution:

2009 Jan. 19: Deposit $5000

Sally has used all her available TFSA room for 2009. However, the next day she found out about a better TFSA account that pays higher interest:

2009 Jan. 20 Withdraw $5000

This gives Sally $5000 of new TFSA room, but not until 2010 when she will have this $5000 plus 2010’s allotment of $5000 for a total of $10,000 worth of room. Not realizing this, she puts the money in her new TFSA the next day:

2009 Jan. 21 Deposit $5000

Sally has now over-contributed by $5000. She will pay a 1% tax ($50) on this over-contribution for January. Sally could have avoided this problem by making an official TFSA transfer rather than a withdrawal and deposit. Sally realized her mistake:

2009 Jan. 22 Withdraw $5000

The TFSA is now empty and according to CRA’s RC243-SCH-A form for excess TFSA amounts, Sally’s tax on excess contributions should stop at $50. However, the method CRA seemed to use to calculate the extra tax for one taxpayer who uses the handle Ref would have Sally paying a total of $600 in taxes because she wouldn’t get credit for the last withdrawal for the months from February to December.

The first clue that something is amiss was the number of people complaining about over-contribution tax amounts exceeding $600, but claiming to have never had more than $5000 in their accounts. Some of these complaints can be found among the comments on this open letter to Jim Flaherty.

Ref produced a spreadsheet to exactly match CRA’s tax demand. Ref modified the numbers a little to protect his or her privacy before sending me a copy. The modified numbers lead to a tax demand of $796, but the actual tax amount owing should be only $367 according to calculation method in CRA’s own example.

Without further confirmation, we can’t be sure that CRA has made mistakes here, or how widespread the problem may be.

I’d be interested in hearing from anyone willing to share their over-contribution tax calculations to confirm whether CRA is doing them incorrectly. I don’t want to see names, SINs, or anything else personal. I’d just like to see the trail of deposits, withdrawals, and the tax calculations. If you’re willing to help, you can send me information at michael.james.money at gmail.com.