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Taxpayer hit with penalty for overcontribution after failing to understand the one-year lag
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In case you take part in your employer’s pension plan, the quantity you’re capable of contribute to your registered retirement savings plan (RRSP) is diminished by one thing referred to as a pension adjustment (PA).
Your PA quantity, which seems in your T4 slip, is the worth of the advantages you earned within the prior yr underneath your employer’s registered pension plans (RPP) and instantly reduces your RRSP deduction restrict for the next yr. The aim of the PA is to restrict your RRSP contributions to the extent that contributions have been made to an RPP.
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Nevertheless it’s necessary to recollect there’s a one-year lag, such that contributions made to your pension plan by both you or your employer in, say, 2023, have an effect on your RRSP deduction restrict for 2024. A failure to understand this lag might probably result in an RRSP overcontribution and penalty tax, which is why one taxpayer ended up in court docket final month.
If a taxpayer makes a contribution to their RRSP that exceeds their deduction restrict, the surplus contribution is taxed at a charge of 1 per cent per 30 days till it’s withdrawn. There’s, nonetheless, a mechanism underneath the Income Tax Act that enables the Canada Revenue Agency to waive this overcontribution tax if the surplus contribution occurred due to a “cheap error” so long as “cheap steps” have been taken to remove the surplus.
If the CRA refuses to waive the tax, taxpayers have the fitting to hunt a judicial overview of the CRA’s choice in Federal Courtroom, which is how the present case got here to trial.
The case concerned a taxpayer, the previous chief government of an airport authority, whose compensation plan included participation in a defined-contribution pension plan. The taxpayer additionally yearly topped up his retirement financial savings by contributing the utmost quantity allowed to his RRSP, as indicated on his annual notices of assessments.
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The taxpayer’s troubles started in 2007, when he opted out of his employer’s pension plan, which had the impact of accelerating the quantity he might contribute to his RRSP. Going ahead, as an alternative of collaborating within the pension plan, his employer supplied him with a lump-sum cost annually equal to that yr’s most allowable RRSP contribution.
As an example, the taxpayer contributed to his RRSP most restrict of $4,925 in 2007, when the utmost annual RRSP greenback restrict for that yr was $19,000, since he was restricted by his pension adjustment from the prior yr. In 2008, when he was not a part of the pension plan, his RRSP contribution restrict for that yr was once more diminished by his 2007 pension adjustment and was solely $4,775, which was indicated on his discover of evaluation.
As a result of the adjustments to his compensation occurred in 2008, the rise to his RRSP contribution restrict would solely come into impact for 2009, when the utmost RRSP contribution was set at $21,000.
The issue was that in January 2008, his employer made an RRSP contribution on his behalf of $20,000, presumably meant to seize the utmost $20,000 RRSP greenback restrict for 2008, which resulted in an extra RRSP contribution of $20,891 from January 2008 to December 2008.
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The surplus contribution existed as a result of the taxpayer’s RRSP contribution restrict for 2008 remained at $4,775 and had not but been adjusted to the 2009 most of $21,000 because of the one-year lag.
In 2009, the taxpayer’s discover of evaluation indicated he might contribute the total yearly most RRSP greenback restrict of $21,000 for that yr. Had the taxpayer not made any RRSP contributions in 2009, the brand new $21,000 contribution restrict might have been utilized to his $20,891 extra contribution from 2008 and would have fastened the overcontribution as of Jan. 1, 2009.
However that’s not what occurred because the taxpayer contributed one other $21,000 to a spousal RRSP in 2009, which means the earlier extra contribution couldn’t be “absorbed by attrition” on Jan. 1, 2009, when his 2009 new RRSP room opened up.
Consequently, the surplus RRSP contribution of $20,891 from 2008 grew to become an extra RRSP contribution for 2009 after which for subsequent years because the taxpayer continued to maximise his RRSP contributions annually till 2015.
The taxpayer was first notified he had an issue on his 2009 discover of evaluation, dated June 3, 2010, which said the taxpayer “might need to pay a tax of 1 per cent per 30 days in your RRSP extra contributions as your unused RRSP contributions … exceed your RRSP deduction restrict.”
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This warning was both ignored by the taxpayer, or maybe not even seen, since he took no motion to repair the issue till the CRA reached out to him once more in 2014 by the use of a letter indicating that he continued to have an extra RRSP overcontribution.
The CRA offered him with two choices: he might both go away the RRSP extra contributions within the RRSPs and pay the overcontribution tax annually, or withdraw the funds from the RRSPs and cease the penalty for future years, however he must embrace the withdrawal as revenue for the yr by which it got here out.
The taxpayer selected a unique method, which was to easily not contribute in 2015 in order that the brand new RRSP restrict in 2015 would soak up, by attrition, the surplus contribution that remained in his RRSPs, acknowledging that he “understand(d) it might not meet with (the CRA’s) necessities.”
The CRA refused the taxpayer’s request to waive the penalty tax, so he sought a judicial overview of the company’s choice in federal court docket, which then determines if the CRA’s choice to not waive the overcontribution tax is cheap. Prior jurisprudence has interpreted this to imply that the choice bears the standard hallmarks of reasonableness: justification, transparency and intelligibility.
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The decide reviewed the details and concluded the CRA’s choice to not cancel the overcontribution tax was cheap because the case legislation supported the CRA officer’s causes {that a} taxpayer who fails to grasp the RRSP scheme or make any inquiries regarding their contribution limits can not show that an error leading to an extra contribution is cheap. Moreover, the taxpayer didn’t take “cheap steps to remove (the overcontribution) in the end.”
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Jamie Golombek, FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Property Planning with CIBC Non-public Wealth in Toronto. Jamie.Golombek@cibc.com.
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