Did you know that the Canada Revenue Agency (CRA) has access to your TFSA information?
It’s not well-known, but it’s true. You can actually test this by logging into CRA MyAccount. If you go into your CRA account and look at the TFSA account stats, you will see that the CRA has details on your contributions and withdrawals on file. By contacting your financial institution (the bank or whatever else your TFSA is held at), the agency can get other information (e.g., account balances) as well.
So, the CRA is always able to watch your TFSA and find out whether you are abiding by the account rules or not. This is why it pays the dot your i’s and cross your t’s when it comes to managing your TFSA. There are several ways you can run afoul of your TFSA’s rules and end up paying taxes on the balance. If you do so, the taxes can, in some scenarios, be rather steep.
In this article, I will explore the three TFSA red flags that the CRA looks out for when deciding which TFSAs to take action on — so you can keep yours in good standing.
Over-contributing
Contributing too much to your TFSA is a major TFSA violation. If you do so, you pay a 1% monthly tax on the amount you contributed that was in excess of your limit. Additionally, any stocks or bonds held in excess of your contribution limit will be taxed the same way they would be taxed in a regular account. So, definitely do not over-contribute to your TFSA. It can earn you a double-whammy of taxation.
As for how to avoid over-contributing, again, CRA MyAccount has the answer. There, you can find exactly how much you have contributed to your TFSA over the course of your investing life and how much you can still contribute.
Small business holdings
If you are a small business owner who owns a corporate entity, you might feel tempted to put shares in your company in your TFSA. Unfortunately, this violates the TFSA rules. CRA guidelines clearly state that shares in a company you control aren’t eligible TFSA securities. So, stick to publicly traded companies, bonds and Guaranteed Investment Certificates when building your TFSA portfolio.
Day trading
Last but not least, we have day trading. Specifically, day trading full time. If you have a full-time career day trading and you carry out the trades in a TFSA and realize huge profits, the CRA is likely to class your trading activities as business activities. If it does so, your gains will be taxed as business income.
Instead of day trading in your TFSA, you might want to consider holding an index fund like iShares S&P/TSX Capped Composite Index Fund (TSX:XIC) in the account. XIC is a broad market Canadian index fund that invests in 240 stocks. This is exactly the type of asset that academic research has found works best for most investors, and it is 100% TFSA-eligible.
The XIC ETF has many things going for it. With 240 holdings, it is plenty diversified. As a Canadian exchange-traded fund, its dividends aren’t subject to foreign withholding taxes. With a 0.05% management expense ratio, it is reasonably priced. And finally, as a large cap highly traded fund, it does not incur too many trading costs for its holders. All in all, holding XIC in a TFSA would be preferable to day trading for most Canadians.
