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Tax-free savings account (TFSA) taxes 

Take advantage of this tax exempt account, which allows you to avoid tax on capital gains, interest and dividends.

With tax season around the corner, you might be wondering about how your TFSA is taxed. Fortunately, TFSAs (tax free savings accounts) are tax-exempt, which means that gains, dividends and interest made within the account are tax-free. However, you may incur a contribution penalty tax if you break the rules of the account, such as exceeding the maximum TFSA contribution. Learn more about TFSA taxes below.

TFSA taxes

As the name suggests, there are no taxes applied to a tax free savings account. When a Canadian contributes to a TFSA, their taxable income is not reduced and there are no tax consequences of withdrawing funds. In addition, interest, dividends and capital gains earned within a TFSA are not taxable.

However, TFSAs have specific contribution rules and there are penalties for a TFSA over-contribution. Every year, the Canadian government specifies a maximum TFSA contribution, and if you exceed that contribution amount you must pay 1% penalty tax on the excess amount for every month the excess remains in the account.

The only other circumstance where you may pay tax on a TFSA is if you become a non-resident of Canada. If you make a contribution to your TFSA when you’re a non-resident of Canada, you’ll be charged a 1% tax on those contributions every month. Generally speaking, a non-resident is someone who resides outside of Canada for the majority of the year (over 183 days).

What is the maximum TFSA contribution?

For the 2021 tax year, the TFSA contribution limit is $6,000.

Keep in mind that unused contribution room rolls over. So, if you didn’t contribute at all in 2020 (when the contribution limit was $6,000), you can contribute a maximum of $12,000 the following year (the 2020 and 2021 contribution limits combined).

To calculate your TFSA contribution room, determine the year you turned 18. Then, sum every contribution limit from that year onward. You can also determine your contribution room by logging into My Account, MyCRA or by calling the CRA.

TFSA over contribution penalty

If you contribute more than your total contribution room, you’re subject to a 1% TFSA over contribution penalty. The 1% penalty is applied every month to the excess balance as it remains in the account.

Let’s look at an example to understand how the TFSA over contribution penalty works. Annette has a current total contribution limit of $12,000. In 2020, she contributed $6,000. In 2021, she contributed $7,000. Currently, her total TFSA balance is $13,000 which is $1,000 over her $12,000 limit. Unfortunately, Annette didn’t notice the error for 4 months. The CRA charges her $40 ($1,000 x 1% x 4 months) for the error. Annette promptly removed the $1,000 and paid the $40 penalty.

TFSA over contribution form

If you incur a TFSA over contribution penalty, you must complete a TFSA over contribution form, also known as the TFSA tax return. If you incurred a penalty as a result of making a contribution to your TFSA when you were a non-resident of Canada, you must complete the TFSA over contribution form as well. The official name for it is Form RC243, Tax-Free Savings Account (TFSA) Return. When you file your annual tax return, be sure to submit this form as well.

Is there a TFSA tax return?

TFSA holders do not normally have a tax payable. For this reason, the average Canadian does not have to worry about a TFSA tax return.

A person may incur tax on their TFSA if they don’t abide by the contribution rules or make a contribution when they’re a non-resident of Canada. In this case, the account holder must complete and submit Form RC243, Tax-Free Savings Account (TFSA) Return. In other words, Form RC243 is the TFSA tax return, but you only need to use this if you overcontributed or made a contribution as a non-resident.

If you incur TFSA taxes and believe they should be waived or cancelled, you can submit a request to the CRA. They will consider the following factors:

  • Tax arose from an understandable error
  • The transaction that caused tax gave rise to other taxation under the Income Tax Act
  • Extent which payments have been made from the person’s TFSA

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Bottom line

If you abide by the rules of a TFSA, you will avoid taxes on the account and will not be required to file a TFSA tax return. If you make a mistake and incur a penalty, you can try to waive it or you can pay the fee and remove the funds from your account. If this is the case, be sure to file the TFSA tax return in the year you incurred the penalty.

Frequently asked questions

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.

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