The TFSA remains one of the best investment vehicles for Canadians to invest in and generate an income that is sheltered from taxes. The more appropriate term should be sheltered from most taxes. Canadians holding U.S. stocks in a TFSA still have some tax obligations. Yes, Canadians can hold U.S. stocks in a TFSA.
Canadian investors are increasingly looking to the U.S. market to fund their portfolios. There are a few good reasons for that. The market is immensely larger, as is the collection of companies. Those companies also represent the largest and often the best picks across any market to invest in. And often, those companies offer attractive dividends.
There’s no shortage of benefits for Canadians holding U.S. stocks in a TFSA. Investors just need to navigate some rules with respect to dividends.
Source: Getty Images
How U.S. stocks in a TFSA are taxed by the IRS
The biggest surprise for many Canadian investors is that the TFSA is not recognized by the IRS as a retirement account. This means that any U.S. stocks held in a TFSA that pay dividends are automatically subject to a 15% withholding tax.
Keep in mind that this happens before the dividend reaches the holder’s account, and there’s no way to recover it through a foreign tax credit or any other mechanism.
That withholding applies across the board, irrespective of the size of the distribution. In fact, the IRS treats TFSA dividends the same way that it treats dividends paid to any non‑resident investor.
Despite the TFSA sheltering Canadians from Canadian taxes, it offers no such protection from U.S. withholding rules. TFSA investors who rely on dividends stemming from U.S. stocks in a TFSA should note that this reduces the effective yield and could limit the effect of long-term compounding.
What this means for dividend‑paying U.S. stocks
Withholding tax becomes more prominent when holding U.S. stocks in a TFSA. Johnson & Johnson (NYSE:JNJ) is a prime example of this. Johnson & Johnson is one of the most popular dividend stocks on the market. The company is best known for its impressive streak of over 63 consecutive years of annual dividend increases.
As of the time of writing, Johnson & Johnson offers a yield of 2.4 %. But for Canadian investors holding U.S. stocks in a TFSA like Johnson & Johnson, that payout will get a 15% haircut before it arrives.
Another example to consider is Apple (NASDAQ:AAPL). As one of the largest tech companies on the planet, Apple prioritizes growth over its dividend. That’s evident in the miniscule 0.38% yield the company offers.
Even with that tiny payout, the withholding still applies. One difference to note, however, is that the payout is already small, and the reduction is minimal, too. The other point to note is that most investors hold Apple not for its dividend, but for long-term growth.
That difference is important because it shows that the type of stock matters when deciding whether to hold.
When a TFSA still makes sense for U.S. holdings
Despite the withholding tax, there are still scenarios where holding U.S. stocks in a TFSA is beneficial. Growth‑oriented companies that generate most of their returns through share price appreciation can still be strong TFSA candidates. If dividends make up only a small portion of total expected returns, the withholding tax becomes a minor factor.
One other example of this comes from one of the largest and best-known companies on the planet. NVIDIA (NASDAQ:NVDA).
NVIDIA, like Apple, is a growth-first stock that prioritizes capital gains over income. The company’s current distribution is more of a rounding error than an actual payout. The yield is a tiny 0.02%.
More importantly, investors who sell their positions in these U.S. stocks in a TFSA will still retain the tax-free benefit. That’s because the taxable event is on dividends, not capital gains.
What stocks are in your TFSA?
Understanding the implications for holding U.S. stocks in a TFSA is key for investors looking to build a cross‑border portfolio. Picking the right stocks that fit your objectives and timeline can make a huge difference over the longer term.
