TFSA Investors: Beware This Huge CRA Tax Bomb

Holding dividend stocks like Fortis Inc (TSX:FTS)(NYSE:FTS) in a TFSA is safe, but doing this one thing could get you in trouble.

| More on:
TFSA and coins

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

If you invest in a Tax-Free Saving Account (TFSA), you expect to pay no taxes on your investments. It’s in the name, after all: tax-free savings account. As long as you hold approved investments and stay within your contribution limit, you should pay no taxes on TFSA stocks. And 99% of the time, it does work out that way. But there is one specific situation where you can find yourself getting taxed–heavily–inside a TFSA. This situation doesn’t apply to most investors, however.

If you trade full time, you’re at increased risk of having it happen to you. In this article, I’ll explore the CRA’s “TFSA tax bomb” and what you can do about it.

Trading professionally in a TFSA

If you trade professionally (i.e., full-time) in a TFSA, you could end up getting taxed even if:

  • All of your investments are approved.
  • Your contributions are within your limit.
  • None of your investments are subject to foreign withholding taxes.

What “trading professionally” means is open to interpretation. But basically if you’re earning a full-time income from trading, the CRA is likely to classify your trading activity as a business. While the standards used to determine whether your trading is a business are somewhat vague, some activities that have gotten people taxed include:

  • Using special software to trade.
  • Not having a full-time job.
  • Earning enormous returns from trading.
  • Using special, paid research services.

Neither one of these factors alone is enough to get the CRA to class you as a business, but enough of them in combination could.

Why it’s considered taxable even in a TFSA

The CRA classes professional trading inside a TFSA as a business because it contravenes the spirit of the account. In Canada, trading full-time is considered a business. The TFSA was not created to shelter such activities from taxation. Instead, it was designed to help working class Canadians save and invest. A person earning $1 million per year from complex derivative trades does not fit that description. Thus, the CRA is more likely to classify their activities by their nature rather than by the account in which they’re conducted.

Foolish takeaway

The bottom line is this:

It pays to invest in them, rather than trade in them.

If you hold a conservative portfolio of “buy and hold” stocks like Fortis (TSX:FTS)(NYSE:FTS) in a TFSA, you can realize enormous tax savings. On a $50,000 position in Fortis stock, you’d get about $1,835 in annual dividends. Inside a TFSA, none of that would be taxable. If you realized a $10,000 gain on Fortis shares in a TFSA, that would not be taxable either. So, investing in conservative Canadian stocks like Fortis in a TFSA is a wise idea.

But if you think you’re going to run a fancy derivatives trading operation in a TFSA and pay no taxes, think again. The CRA has the tools at its disposal to find trading businesses that are being run inside TFSAs. So stick to boring old “buy and hold” stocks like Fortis. In the long run, it pays off.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends FORTIS INC.

More on Dividend Stocks

Happy family father of mother and child daughter launch a kite on nature at sunset
Dividend Stocks

Parents: Here’s Every Credit and Benefit You Can Claim From the CRA

Parents have it hard already, so make sure the CRA is doing everything for you by dishing out payments you're…

Read more »

edit Colleagues chat over ketchup chips
Dividend Stocks

3 Canadian Dividend Stocks to Buy and Hold for Life

These dividend-paying stocks have solid earnings base to support their payouts for decades.

Read more »

A golden egg in a nest
Dividend Stocks

Create a Million-Dollar TFSA With Just $1,000

If you have a TFSA, you can easily make a million-dollar portfolio by investing on a consistent basis in this…

Read more »

Dollar symbol and Canadian flag on keyboard
Dividend Stocks

3 Canadian Stocks With Over 6% of Dividend Yield

Boost your passive income with three safe dividend stocks.

Read more »

TFSA and coins
Dividend Stocks

TFSA Pension: 2 TSX Dividend Stocks to Buy Now and Hold for Decades

These top TSX stocks pay great dividends and look cheap to buy right now for a TFSA retirement fund.

Read more »

Dividend Stocks

TFSA Dividend Income: 2 TSX Stocks to Buy on the Pullback

These TSX stocks look oversold and pay attractive dividends that continue to grow.

Read more »

oil tank at night
Dividend Stocks

1 Top TSX Energy Stocks for Summer 2022

TSX energy stocks have tanked recently, but they could enjoy a nice summer rally. Here's one top stock I'm eyeing…

Read more »

Dividend Stocks

Market Correction: 2 Cheap TSX Dividend Stocks to Buy Now for a Self-Directed RRSP

These top TSX dividend stocks look cheap right now for a self-directed RRSP focused on total returns.

Read more »