Posted by Canadian Dream on June 17, 2010
Well if you’ve been following the media lately you would have likely seen a few articles/posts on people who got big tax bill because they didn’t understand how their TFSA accounts work. When you take money out of a TFSA you don’t get your contribution room back until the following year. So you if put in $5000 to start and then took out $3000 and then try to put back the $3000 in the same year you would be over contributing by $3000 and end up with a 1% penalty per month on the over contribution amount. If you are in that situation you might have a hope of not paying the tax bill, see this article by Rob Carrick which points out which form you will need to fill out.
I think perhaps people lost sight that this is a savings account and the government what’s to keep people from trying to use it as a chequing account. They want you to save, not just for next week, but rather next year or longer. Hence the odd rules. To be fair about this situation, the rules were not all that well explained when these new accounts were introduced.
I don’t think I even understood them exactly. In my case I just screwed up my math and ended up over contributing by $10 to my TFSA because I didn’t check the amount of my last contribution. I realized this after about two months and then took the over contribution out. So my tax penalty is a whole $10 x 1% x 2 months = $0.20, so needless to say I’ve not received a letter from the government as the postage they use on the letter would cost more than what I ‘owe’.
Yet what I found particularly interesting was on my notice of assessment it showed my 2010 contribution limit to be $5010. So if I understand it correctly then my over contribution actually resulted in me gaining contribution room the next year (actually this was my fault I realized later on…I took out $20, not $10 to fix my overcontribution). Obviously this just sounds wrong, since if this is correct you should in theory you could ‘buy’ extra contribution room. For example, you over contribute by $5000 in Nov, then take out the excess in Dec. Pay your $50 penalty and end up with an extra $5000 in contribution room the following year.
So after reading a little on the government’s TFSA site I think I understand why my $5000 example won’t work. If you deliberately over contribute to your TFSA, you will likely trigger the ‘advantage’ clause and get nailed with losing that extra contribution room. Yet based on my own experience there is some grey area, so I wondering if anyone else generated extra contribution room from their ’screw up’? If so, how much? I’m curious to see if there is a set limit or not.
Posted by Dave on June 8, 2010
As I frantically study for an exam on the Canadian Tax System tomorrow, I came across the above topic that I thought would be worth discussing.
Many people who are aiming for early retirement are planning on using dividends to at least partially replace income previously earned through employment. I think most people know that investing in Canadian public companies gives the benefit of dividend tax credits, and today I thought I would explain why there are dividend tax credits and how these credits fit in with the Canadian tax system.
The dividend tax credit system is set up to eliminate the potential of double taxation of investment income. Without special tax rules, dividends would be taxed once at the corporate level and then again at the shareholder level when dividends are paid. Although this would be ideal in the current economic climate (our government would end up with more tax dollars, which is something they are searching for at the moment) it is not all that equitable to businesses and individuals, hence Canada’s integrated tax system.
The best way to explain this premise I think is an example. For this theoretical example, I’ve simplified some of the information, but it should provide an explanation of what I’m talking about.
A corporation earns $100, of which all after tax dollars are to be allocated to dividends. The gross-up rate being used in the example is 1.45, which is the rate used on active publicly-traded corporations for last year. The tax credit calculated is 31%, which is what was applied in British Columbia for 2009:
Federal Tax rate on $100 19.50
Provincial tax on $100 11.50
Total 31.00
Dividend Available 69.00
Grossed up at 1.45* 100.00
Dividend tax credit 31.00
So, essentially what the dividend tax credit ensures is that the $31.00 already collected by the Canada Revenue Agency is not collected on again. Dividend income itself is taxed on the individual, but if you follow the math, the individual would have a credit from the $69.00 received and would only be taxed on $38.00 of dividend income in this simplified example.
The dividend tax credit is only available to Canadian dividends. The Canada Revenue Agency really doesn’t care if they’re double taxing you on foreign dividends, as another government received the benefit of the corporate portion ($31.00 from the example above). The ramification of this double taxation means that other than allowing your portfolio to become more diversified on a currency basis, you lose out if you’re investing in a foreign company if there is a comparable domestic stock that could be bought.
The dividend tax credit also makes it much more beneficial (tax-wise) compared to other sources of income (such as interest) which don’t have similar credits available.
Of note, dividend credit is going to be decreasing over the next few years, as corporate taxes are declining and in order to match the lower amount of taxes being paid by corporations, shareholders will get less as a credit. The following amounts show the federal dividend tax credit amounts on dividends paid from a public corporation in Canada (provincial amounts vary across the country).
2009 = 27.5%
2010 = 25.88%
2011 = 24.12%
After 2011 = 22.35%
So, I hope I have provided some information as to why we have a dividend tax credit and the overall implications of the credit on the Canadian tax system. Any questions?
Posted by Canadian Dream on April 15, 2010
As I was entering the last few tax forms that are coming in (invest income is good, but waiting for the tax forms takes forever) into QuickTax I’m finding myself looking at an unfamiliar sight. I owe taxes?!?!
You have to realize that I’m used to my wife owing a little bit of CPP each year, but I’m in a bit of a surprise that I personally own anything. I’ve been on refunds for such a long time that I’m having some difficultly adjusting, since I usually leave a bit of cushion on my tax planning to make sure I have a small refund. Yet in hindsight this isn’t surprising at all for a few reasons.
- Second Job – It’s just about impossible when taking a second job to have the right amount of tax coming off at the start, unless you are very good at calculating the tax implications of that additional income. I’m not that good, I always seem to be off a bit.
- Selling some stocks – Upon opening our TFSA’s in 2009 we sold off some stocks in our taxable accounts which triggered capital gains/losses.
- Home Buyers Plan – When I did my tax planning I messed up a little bit and forgot about my home buyers plan repayment, which is about $700.
All in all it’s not much that I owe, about $300 right now. So from a tax planning side I did fairly well, I’m just off a little bit from owing/refund goal of $0. A reminder the deadline to file is April 30 in Canada.
So how did you do on your taxes this year? Are you having a refund or do you owe?
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Filed Under: Tax
