Don’t overcontribute to your RRSP
There are just four days left to make your RRSP contribution to reap the benefits of a tax deduction on your 2011 return. In the rush to meet the deadline, be sure to take extra caution so that you don’t end up overcontributing.
Your RRSP contribution limit is generally 18% of your prior year’s earned income (up to a maximum of $22,450 for 2011), less any pension adjustment plus any room carried forward from prior years. The penalty for overcontributing beyond the allowable $2,000 safety zone is 1% per month on overcontributed amounts.
If you accidentally end up contributing more to your RRSP than you’re allowed, you can correct this by requesting a withdrawal from your RRSP issuer. While the amount withdrawn will be subject to withholding tax, this can be recovered later when you file your tax return.
Note that you will still be responsible for the 1% penalty tax for each month the overcontributed amount remained in your RRSP prior to withdrawal so it’s best to withdraw the excess as soon as you become aware of it.
The penalty tax is calculated on Form T1-OVP, “2011 Individual Tax Return for RRSP Excess Contributions”, which must be filed within 90 days of the end of the year in which you have an excess RRSP contribution (beyond the $2,000 permitted overage). Failure to file this form on time will lead to additional penalties and interest.
Fortunately, the Tax Act provides relief from this overcontribution tax where the excess amount arose “as a consequence of a reasonable error” and “reasonable steps are being taken to eliminate the excess.”
What is “reasonable error”? A recent case demonstrates that sheer ignorance of the tax law and of your RRSP limit is no excuse.
Sandeep Kapil, who moved to Montreal from the U.S. in 2008, faced $1,600 of overcontribution penalty tax along with a T1-OVP late-filing penalty of $224 and arrears interest of $91 for making a 2008 RRSP contribution when he was unable to do so. That’s because RRSP contribution room is based on the prior year’s earned income, which must be earned while a resident of Canada.
Mr. Kapil wrote to the CRA requesting that the overcontribution tax be cancelled, along with the penalties and interest charged. CRA refused saying that the “the excess contributions were not the product of a reasonable error.” He thus found himself in Federal Court asking the judge to review whether CRA’s decision refusing to waive tax, interest and penalties was justified.
Although Mr. Kapil tried to argue that he was not aware that he was precluded from making RRSP contributions in his first year of Canadian employment, the judge had no mercy. He cited a prior decision which concluded that “it was up to the applicant to ensure that she did not make excessive contributions to her RRSP and her lack of understanding of the law is not a reasonable error. The tax system is admittedly complex and when taxpayers are faced with complexity they are expected to seek advice.”