Beware of what can go wrong if someone with a TFSA dies

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Although tax-free savings accounts (TFSAs) have been round for some time, there’s nonetheless some confusion about what occurs on the demise of a TFSA holder. The tax penalties and alternative for continued tax-free development within the palms of the heir will rely on who receives your TFSA proceeds.

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A current tax case, determined late final yr, reveals what can occur when a TFSA holder dies and the funds are incorrectly dealt with by the beneficiary.

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As a refresher, underneath the tax guidelines, when the holder of a TFSA dies the honest market worth of the TFSA instantly earlier than demise is taken into account to be acquired by the holder tax-free. The holder had the selection of naming both a “successor holder” or beneficiary.

The successor holder can solely be your surviving partner or common-law companion. When you title a successor holder, the TFSA continues rising tax-free after you’re gone, they usually grow to be the brand new TFSA holder.

When you don’t title your partner because the successor, you’ll be able to title them because the beneficiary of your TFSA. In that case, they’ve till Dec. 31 of the yr following the yr of your demise to contribute any funds acquired out of your TFSA, as much as the date of demise worth, into their very own TFSA with out affecting their unused TFSA contribution room. This is called an “exempt contribution,” and the surviving partner should report it to the Canada Revenue Agency on Kind RC240, Designation of an Exempt Contribution TFSA, inside 30 days after the contribution is made.

The drawback right here is that every one revenue earned contained in the TFSA, in addition to any enhance within the honest market worth of the TFSA’s belongings out of your date of demise till the date the TFSA is paid out to your beneficiary, shall be taxable as extraordinary revenue to the beneficiary. This consists of quantities that in any other case could also be tax-preferred Canadian dividends or 50 per cent taxable capital features. That’s why you probably have a partner, it’s typically greatest to call them as a successor holder as a substitute of the beneficiary.

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When you don’t plan to go away your TFSA to your partner, and both title somebody apart from your partner as your TFSA beneficiary otherwise you merely don’t title anybody and the TFSA proceeds are paid to the property, any revenue earned within the TFSA after the date the holder died will merely be taxable to the beneficiary (or the property) as extraordinary revenue.

A failure to know these guidelines can result in TFSA hassle, as one taxpayer discovered it in a case determined in December 2024. The taxpayer went to federal court docket in search of a judicial evaluate of the CRA’s determination to not cancel the penalty tax imposed upon him associated to extra contributions he made to his TFSA after the demise of his mom.

Underneath the Income Tax Act, a person who overcontributes to their TFSA is required to pay a tax on the surplus quantity equal to at least one per cent per 30 days of the surplus contributions. The Tax Act, nevertheless, offers the CRA the discretion to waive or cancel this penalty tax if the taxpayer can set up that the tax legal responsibility arose as a consequence of a “affordable error,” and the surplus TFSA funds are faraway from the TFSA “immediately.”

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The taxpayer’s troubles started again in 2019. On January 1, 2019, the taxpayer contributed $6,000 to his TFSA account, his restrict for the yr. The taxpayer’s mom died on June 7, 2019, and he was the designated beneficiary of her TFSA. Because of this, the taxpayer acquired her TFSA proceeds, tax-free, within the quantity of $59,779. He selected to switch this quantity to his TFSA account on June 18, 2019, regardless of not having any obtainable TFSA contribution room.

This resulted in a right away overcontribution, which was caught by the CRA the next summer season when the taxpayer was assessed overcontribution tax, and was suggested to withdraw the quantity instantly.

In late July 2020, the taxpayer requested that the CRA designate the TFSA proceeds he had acquired from his mom’s TFSA as an exempt contribution on the premise that he was a survivor of his mom such that there could be no penalty tax for 2019. He eliminated the overcontribution from his TFSA on September 23, 2020.

The next month, in October 2020, the taxpayer requested that the CRA cancel the tax assessed on the overcontribution for the 2019 taxation yr. The Applicant based mostly his request on three components: he was affected by psychological misery, he relied on incorrect info, and he had eliminated the overcontribution “immediately.”

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In November 2020, the CRA notified the taxpayer that his request to deal with the contribution as an exempt contribution couldn’t be processed as a result of the taxpayer was not the partner or common-law companion of the deceased, and subsequently didn’t qualify as a “survivor.” The CRA suggested the taxpayer {that a} TFSA beneficiary can contribute any of the quantities acquired upon the demise of a TFSA holder to their very own TFSA, however they will need to have contribution room obtainable to take action, which was not the case right here.

In February 2021, the CRA issued a primary stage evaluate determination refusing the taxpayer’s request to cancel the overcontribution tax for the 2019 taxation, as this was not the primary time the taxpayer had overcontributed. In keeping with the CRA’s information, extra contributions have been made to the taxpayer’s TFSA again in 2015, and the taxpayer had been despatched an “training letter” in Might 2016, which warned him of his overcontribution and potential penalty tax.

In March 2021, the taxpayer requested the CRA to rethink its determination to not waive the tax, explaining that he had been affected by psychological misery. The CRA requested some kind of medical proof, however the taxpayer was unable to supply any, saying that “it was not possible to get physician’s appointments in the course of the COVID-19 pandemic and (that)… he was too overwhelmed to take care of the CRA’s request on the time.”

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The CRA denied his second-level request, so the taxpayer sought a judicial evaluate of the CRA’s determination. As in prior such circumstances, the taxpayer bears the burden of exhibiting that the CRA’s determination was unreasonable in that it “lacks the hallmarks of justification, intelligibility and transparency.”

Whereas the choose was sympathetic, noting that “whereas the circumstances underneath which the (taxpayer) made the overcontribution have been unquestionably irritating,” she concluded that the CRA’s determination to not waive the tax was affordable.

Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Property Planning with CIBC Personal Wealth in Toronto. [email protected].

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