As you are about to start thinking about your 2006 tax return, or possibly a nice tax refund, the government has decided to give you a little something extra to ponder. The Canada Revenue Agency (CRA) has begun an aggressive campaign to collect tax penalties from Canadian taxpayers who have made over contributions to their RRSP. In an effort to determine if there has been an RRSP over contribution that is subject to penalty tax the CRA is sending out letters to Canadian citizens asking them to substantiate the amount of RRSP contributed. Certain over contribution amounts are subject to a penalty tax at the rate of 1% per month.

Until the mid-1990s, your over contribution limit was $8,000. This limit was then reduced to $2,000. Any amount contributed over this limit is subject to the penalty tax of 1% per month. The problem was that until recently the CRA had no way of identifying taxpayers who had over contributed. That is unless the taxpayer volunteered the information. On May 1, 2004 a new rule took effect. Now financial institutions are obligated to send an electronic file to the CRA informing them of the amount and the person who made the contribution. Until then financial institutions that sold RRSP investments had no obligations to report contributions directly to the CRA.

So if you may have made an over contribution to your RRSP over the last ten years you may be targeted by the CRA. Even if it turns out that you are not subject to any tax penalties, taxpayers will have to expend a significant amount of time, energy and effort in coming up with the requested receipts that the CRA is demanding.

Here’s an example of how an honest taxpayer could face a nightmare of red tape, paperwork and hassle. You have already purchased $18,000 in RRSPs for your 2006 limit but you want to get ahead of the game for 2007, so you make another $18,000 contribution within the first 60 days of 2007. Everything is fine, as you can use the first 60 days contribution in 2006 if needed, or apply it to 2007 taxes. You complete your 2006 tax return and you claim your 2006 limit plus your contribution made in the first 60 days of 2007. You receive your Notice of Assessment showing that you have an over contribution of $18,000. The big computer at the CRA starts flashing warning signals and an over contribution letter goes out to you for an explanation. It’s now up to you to prove to the CRA that you have done everything above board and no penalty tax should apply.

You should know how to respond if the CRA sets their sights on you. Keep your records of RRSP contributions handy so that you will have your proof and there will be no confusion on the dates that you made your contributions. If it turns out that you are subject to tax penalties, you should make every effort to correct the situation as quickly as possible. The CRA will demand collection of the penalty tax at the rate of 1% per month plus, they may also charge interest on the amount owing and a late filing penalty.

This is a monthly article on financial planning. Call or write to Rick Sutherland CLU, CFP, FDS, R.F.P., of Fundex Investments with your topics of interest at 798-2421 or E-mail at rick@invested-interest.ca.