Getting taxed in your TFSA is not an experience that most people expect. But for a small handful, it happens. Although TFSAs are marketed as tax-free accounts, some people do end up getting taxed within them. Chiefly, by running trading businesses in their accounts. Although TFSAs spare you from having to pay taxes on investments, they do not exempt you from the taxes that you have to pay if the Canada Revenue Agency thinks you’re running a business.
You can be investigated for running a day trading business in a TFSA if you achieve an unusually high account balance. The risk is elevated if you work as a financial adviser. If you’re found to be day trading full time, you’ll likely be taxed. Fortunately, there is one simple investing strategy you can use to reduce the chances of that happening. In this article I will explore how you can avoid TFSA taxes by following a buy-and-hold investing strategy.
What gets you taxed in a TFSA
There are generally two conditions that, when combined, lead to you getting taxed as a business in your TFSA:
- Day trading
- Large profits
Day trading in itself is not against TFSA rules. However, if you make huge profits doing it – to the point where you get a multi-million dollar account balance – you may end up getting taxed. The problem is that when you make a lot of money day trading, it looks like a business. You’re sitting in front of your computer doing this all day, like any other job – isn’t this a form of self-employment?
Several Canadians have been found to be running day trading businesses in their TFSAs, and they haven’t had much success in getting the judgments overruled. Just recently, a Canadian financial advisor with millions in TFSA profits was found to be running a trading business. He appealed but lost. This experience has been pretty common for Canadians who found themselves on the wrong side of the CRA over the years.
How buy-and-hold investing can spare you potential taxation
Having explored the unfortunate reality of getting taxed for day trading in a TFSA, we can now move on to the good news:
You can easily avoid this fate, namely, by following a buy-and-hold strategy. Simply sitting on investments for long periods of time is not a business: to be running a business, you have to be doing something. Buying and holding is not work, so it’s hard to say that you’re running a business when you’re just sitting on passive stock holdings.
We can illustrate how this works by considering a hypothetical investor who buys Enbridge Inc. (TSX:ENB) stock in their TFSA. Enbridge is a dividend stock with a 6.6% yield. If you invest a fully maxed out TFSA ($88,000) into ENB stock, you’ll get about $5,808 back in passive income each year. On top of that, you could get a capital gain, which could add another few thousand dollars to your return at the end of your holding period.
Enbridge’s dividends have been steadily rising over the course of many decades. If you hold the stock in the future, and if it performs similarly to how it performed in the past, you could be getting tens of thousands of dollars in dividends each year. And because you’ll have held rather than traded your ENB stock, it will be hard for the CRA to claim you were running a trading business in your account.