Tax Free Savings Account and its Tax Implications

Nature of Tax Free Savings Account (TFSA):

As we all know, investment in TFSA is a great way of tax planning. As the name implies, income earned in TFSA is tax free not only at the time of earning but even at the time of withdrawal from it. Any contribution made to TFSA is not tax deductible and at the same time not taxable upon its withdrawal.

However, investment made in TFSA is subject to the limit laid down by CRA. Each Canadian Resident who is 18 years or more is eligible to contribute to TFSA. If you did not invest anything in TFSA so far, you can contribute up to $46,500 in TFSA. However, in case if you invested in TFSA, the amount of investment will be reduced to arrive at the remaining limit of TFSA.

What happens when you withdraw from TFSA?

When you withdraw from TFSA, of course the withdrawal is not taxable but more importantly the fresh room is crested not in the year of withdrawal but only in the next year (after the year of withdrawal). This is very important because it is unlike Registered Retirement Savings Plan (RRSP) where the additional limit is created immediately (in the same year) upon the withdrawal from RRSP. Many taxpayers had been served with the notice of excess contribution in TFSA by Canada Revenue Agency (CRA) in the past years. Please note that excess contribution in TFSA (over the limit) is penalized by 1% p.m. for the period for which the investment exceeds TFSA limit.

TFSA and Designation of Beneficiaries:

When an investment in TFSA is made, beneficiary of this fund can be designated and this beneficiary will receive the funds in the event of the death of the tax payer. When such beneficiary is designated, beneficiary can contribute any amount he receives in his own TFSA subject to his unused contribution limit in his TFSA. Of course, inheritance is all tax-free.

A survivor who is a beneficiary has the option to contribute and designate all or a portion of a survivor payment as an exempt contribution to their own TFSA, without affecting their own unused TFSA contribution room, as long as they meet certain conditions and limits. For more information, see Designation of an exempt contribution by a survivor.

If, at the time of death, there was an excess TFSA amount in the deceased holder's TFSA account, a tax of 1% per month is applicable on the highest excess amount for each month in which the excess remained, up to and including the month of death.

Nominating a Successor Holder:

As against the nomination of Designated Beneficiary, what seems better tax planning is nomination of a Successor Holder. In this situation, the TFSA continues to exist and the successor holder assumes ownership of the TFSA contract and all of its contents. However, where the TFSA contract is a trust arrangement, the trust continues to be the legal owner of the property held in the TFSA.

Successor Holder can either separately and independently manage the Deceased Taxpayer’s TFSA and his own TFSA or the two TFSA accounts can be merged as well.

The TFSA continues to exist and both its value at the date of the original holder's death and any income earned after that date continue to be sheltered from tax under the new successor holder.

Except in cases where an excess TFSA amount existed in the deceased holder's TFSA at the time of their death, the successor holder's unused TFSA contribution room is unaffected by their having assumed ownership of the deceased holder's account.

The issuer will notify the CRA of this change in ownership.

The successor holder, after taking over ownership of the deceased holder's TFSA, can make tax-free withdrawals from that account. The successor holder can also make new contributions to that account, subject to their own unused TFSA contribution room.

If the successor holder already had their own TFSA, then they would be considered as the holder of two separate accounts. If they wish, they can directly transfer part or all of the value from one to the other (for example, to consolidate accounts). This would be considered as a qualifying transfer and would not affect available TFSA contribution room.

In certain cases, a survivor, designated as the successor holder of a TFSA, may not have a valid Canadian social insurance number (SIN), which is one of the eligibility requirements for opening a TFSA. If the survivor is a Canadian resident, they should apply to Service Canada to obtain a valid Canadian SIN.

If the survivor is a non-resident, they should request an individual tax number from the CRA by filling out Form T1261, Application for a Canada Revenue Agency Individual Tax Number (ITN) for Non-Residents.

Hope this helps clarifying some of the aspects of TFSA.

Disclaimer: Any discussion on this blog relating to tax matters is purely for educational purposes and not taking any specific actions based the general tax rules described therein. Your tax situation could be different and as a result there may be different tax strategies applicable in your case. We do not claim the tax situations described above to be exhaustive or conclusive. In case of any specific tax situations or problems, you are advised to seek professional advice.

Tax implications of Buying a new Home

All of us know the surge that we are going through in the housing market in Provinces like Ontario and British Columbia. I just want to analyse the tax implications of buying a new home.

New home that you may buy could either fall in the category of Principal Residence or not. Principal Residence could be any dwelling unit such as Detached home, Semi-detached home, townhouse, condominium etc. When you use the new home for your personal residence purposes, it is regarded as Principal Residence. Between two spouses, there is only one Principal Residence Exemption.

Tax implications:

1)      If you buy a new home that is your Principal Residence, you are entitled to a Federal tax credit break called “Home Buyers Amount” of $5,000 giving a tax break of $750 from the Federal tax liability.

2)      If you were renting before buying your new home, now you can no longer claim your rent for Ontario Trillium Benefits or any other rent based credit in other Provinces. However, you can claim the property tax paid during the year for the above credit in the province in which it is allowed. Of course, these benefits are income dependant. In the year of buying new home, you can claim both, the rent for the period of renting and property taxes paid during the year. This can be found from lawyer’s Statement of Adjustment Statement”.

3)      If and When you dispose off this Principal Residence, there will be no Capital Gains Tax liability under current rules.

4)      You may be able to claim proportionate Home Office Expenses as a deduction if you are running your self-employed business from this home. If you are employed and want to claim proportionate share of home office expenses, your employer must certify this for you in Form T2200. Depending on the tax situations, you may be able to claim the proportionate share of rent, utilities, insurance on home, property tax, interest on mortgage. Principal payment of mortgage is never allowed as a deduction since it only increases the value of your home.

5)      Please be careful that in trying to claim the above expenses, never claim proportionate share of Capital Cost Allowance (CCA) since claiming the same would amount to forgoing the Principal Residence status as per tax rule and at the time of disposition of your Principal Residence you may be asked to pay the proportionate tax on the Capital Gains earned.

6)      If the new home bought does not represent your Principal Residence and if you let it out for a rental income, you will be taxed on the net rental income earned from that home. In arriving at net rental income you can deduct, the rental expenses as described above for the area rented.

7)      Capital Gains earned at the time of disposition of home described in 6) above will be included at 50% of the amount of capital gains and you will be liable to be taxed at your marginal rate of taxation.

8)      If the new home that you bought is not your Principal Residence (and you already have another home as your Principal Residence), you can file an election to treat your new home as Principal Residence provided you have stayed in your new home for some time at least. This Election will be valid for 4 years. This Election is important in calculating your Principal Residence Exemption.     

Disclaimer: Any discussion on this blog relating to tax matters is purely for educational purposes and not taking any specific actions based the general tax rules described therein. Your tax situation could be different and as a result there may be different tax strategies applicable in your case. We do not claim the tax situations described above to be exhaustive or conclusive. In case of any specific tax situations or problems, you are advised to seek professional advice.