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

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

Bad apple with good apples
Dividend Stocks

Safe and Sound Stocks for Canadians: My Top 5 Choices

Want some of the best stocks for Canadians right now? Here's my top 5 list of stocks to buy today…

Read more »

A close up image of Canadian $20 Dollar bills
Dividend Stocks

2 TSX Dividend Stocks With Yields Above 7% That You Can Buy With $100

Here are two high-yielding TSX dividend stocks you can buy with less than $100 per share today and hold for…

Read more »

oil and gas pipeline
Dividend Stocks

Should You Buy Enbridge Stock on a Pullback?

Down 25% from all-time highs, Enbridge stock remains a top investment choice due to its diversified business and steady cash…

Read more »

Redwood trees stretch up to the sunlight.
Dividend Stocks

2 Fantastic Growth Stocks to Buy Right Now

These two growth stocks aren't your average growth stocks, as shares rise higher and higher after earnings, and more's to…

Read more »

Businessmen teamwork brainstorming meeting.
Dividend Stocks

1 Magnificent Dividend Stock Down 15% to Buy and Hold Forever

Enbridge is off the 12-month lows but still trades at a large discount to its 2022 high.

Read more »

Increasing yield
Dividend Stocks

My Top 5 Ultra-High-Yield Dividend Stocks to Buy in May

If you’re looking to build a passive-income stream, these five dividend stocks should be on your radar.

Read more »

Payday ringed on a calendar
Dividend Stocks

A 10.6% Dividend Stock That Provides Monthly Cash Payments

A dividend stock with a mouth-watering yield providing monthly cash flow streams.

Read more »

Dividend Stocks

The Top Canadian REITs to Buy in May 2024

These three REITs have envious growth potential and trade cheaply today, making them three of the top Canadian stocks to…

Read more »