Written on behalf of Feigenbaum Consulting
With tax season looming for both Americans and Canadians, many people are naturally beginning to think of ways they can save money at tax time while also complying with tax laws. In Canada, one of the easiest ways to reduce taxes is to make contributions to a Registered Retirement Savings Plan (RRSP). One of the unique features of an RRSP is that people have until March 1 to make RRSP contributions that will count as contributions made in the previous calendar year. This means that contributions made on February 20, 2022 will result in reduced taxes for the 2021 tax year.
However, there are some important things to keep in mind when it comes to RRSP contributions. The first is that individuals do not have unlimited contribution room for their RRSPs. In 2021, the limit is the lesser of either 18% of earned income or $27,830. Any contributions made over those limits will be subjected to penalties. The second consideration to keep in mind is that not all types of income count as earned income, and therefore not all income someone receives in a given year will help raise their contribution limit. As we see in a recent decision from the Tax Court of Canada, Wyrstiuk v. The Queen, a misunderstanding over what counts as earned income could lead to financial penalties imposed by the Canada Revenue Agency.
Employee is Terminated and Puts Some Severance Money Towards RRSPs
The taxpayer in the matter was an individual who lost a job he had held for 12 years in 2013. He worked with a lawyer to negotiate a severance payment from the employer and was successful in securing a payment of about $165,000. This money was received by the taxpayer in 2014 and he included it in his taxable income for that year.
On February 2, 2015, the employee made an RRSP contribution of about $24,270 in order to reduce his tax liabilities for the 2014 tax year. All was well and good until 2018 when the CRA assessed the taxpayer in respect to the 2015 tax year. The CRA imposed a penalty of about $1,100, equal to 1% of the overcontributions the CRA claimed the taxpayer made in 2015.
Did the Taxpayer Overcontribute to His RRSPs?
The court stated there are two issues that had to be resolved. The first was whether the taxpayer’s RRSP contributions in February 2015 put him over the limit, while the second issue was what, if any, penalties should be applied to him.
In order to determine whether there was an overcontribution, the court had to first determine if the income the employee received as a result of his termination counted as “earned income.” The Income Tax Act defines “earned income” as employment income, stating,
“a taxpayer’s income for a taxation year from … employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year.”
The taxpayer’s position was that payment from his former employer formed part of his remuneration from work and was therefore employment income. After all, he would not have received the income had he not been an employee. In the alternative, the taxpayer said that if the severance payout was not employment income, it should not have been taxed as such when he received it.
The Income Tax Act used to contain language that prevented such payments from being taxed because they were not to be considered employment income. However, amendments have since introduced “retirement allowance” into the Act. The Act now states,
Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year,
(a) any amount received by the taxpayer in the year as, on account or in lieu of payment of, or in satisfaction of,
(ii) a retiring allowance, other than an amount received out of or under an employee benefit plan, a retirement compensation arrangement or a salary deferral arrangement,”
What this all means is that payments such as what the taxpayer received should be considered “other income” as opposed to “income from employment.” This means that money cannot count towards his RRSP contribution limit.
What Penalty Should be Imposed on the Taxpayer?
If the contributions made to the taxpayer’s RRSPs put him over the limit, the court had to determine what penalties he should have been subjected to. The court said that while RRSP contributions made during the first 60 days of a calendar year can count as contributions made the year prior, they can also be counted as contributions in the year they are made, which the taxpayer was likely to have wanted as an alternative.
In this case, the court found that the taxpayer had $20,544 of unused contributions available in 2015, and as such the deposits he made to his RRSP that he intended to apply to 2014 should be applied to 2015, leaving him with a smaller overage of just about $4,000. The tax on that was reduced to $682.33 and his penalty was reduced to just $116.
Let Feigenbaum Law Help You with Any Issues You Experience with Your Personal or Business tax
While the taxpayer, in this case, was partially successful on appeal, the whole situation could have been avoided with careful tax planning in the first place. At Feigenbaum Law, we understand the important role that skillful tax planning can play in providing our clients with the security of knowing that no stone has been left unturned in an effort to reduce tax obligations while staying inside the confines of tax legislation. Our own Mark Feigenbaum has an extensive background in law, tax, and cross-border issues related to personal or business income and tax. As such, our team is in a unique position to assist clients in a wide range of matters, including personal tax compliance. To find out how we can help you please reach us online or call our office at 1-877-275-4792.