Watch out for what can go fallacious if somebody with a TFSA dies

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

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A current tax case, determined late final 12 months, exhibits 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, beneath the tax guidelines, when the holder of a TFSA dies the honest market worth of the TFSA instantly earlier than dying is taken into account to be obtained 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. In the event you identify a successor holder, the TFSA continues rising tax-free after you’re gone, they usually turn out to be the brand new TFSA holder.

In the event you don’t identify your partner because the successor, you’ll be able to identify them because the beneficiary of your TFSA. If that’s the case, they’ve till Dec. 31 of the 12 months following the 12 months of your dying to contribute any funds obtained out of your TFSA, as much as the date of dying worth, into their very own TFSA with out affecting their unused TFSA contribution room. This is named an “exempt contribution,” and the surviving partner should report it to the Canada Income Company on Kind RC240, Designation of an Exempt Contribution TFSA, inside 30 days after the contribution is made.

The drawback right here is that each one revenue earned contained in the TFSA, in addition to any improve within the honest market worth of the TFSA’s property out of your date of dying till the date the TFSA is paid out to your beneficiary, can be taxable as atypical 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 usually finest to call them as a successor holder as a substitute of the beneficiary.

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In the event you don’t plan to go away your TFSA to your partner, and both identify somebody aside from your partner as your TFSA beneficiary otherwise you merely don’t identify 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 atypical revenue.

A failure to grasp these guidelines can result in TFSA bother, as one taxpayer discovered it in a case determined in December 2024. The taxpayer went to federal courtroom in search of a judicial evaluation 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 dying of his mom.

Below the Revenue 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, nonetheless, 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 “at once.”

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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 12 months. The taxpayer’s mom died on June 7, 2019, and he was the designated beneficiary of her TFSA. Because of this, the taxpayer obtained 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 out there TFSA contribution room.

This resulted in an instantaneous 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 obtained from his mom’s TFSA as an exempt contribution on the idea that he was a survivor of his mom such that there can 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 12 months. The Applicant primarily based his request on three elements: he was affected by psychological misery, he relied on incorrect info, and he had eliminated the overcontribution “at once.”

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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 due to this fact didn’t qualify as a “survivor.” The CRA suggested the taxpayer {that a} TFSA beneficiary can contribute any of the quantities obtained upon the dying of a TFSA holder to their very own TFSA, however they should have contribution room out there to take action, which was not the case right here.

In February 2021, the CRA issued a primary degree evaluation 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 had been made to the taxpayer’s TFSA again in 2015, and the taxpayer had been despatched an “schooling letter” in Could 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 offer any, saying that “it was not possible to get physician’s appointments through the COVID-19 pandemic and (that)… he was too overwhelmed to cope with the CRA’s request on the time.”

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

Whereas the decide was sympathetic, noting that “whereas the circumstances beneath which the (taxpayer) made the overcontribution had been unquestionably hectic,” 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. Jamie.Golombek@cibc.com.

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