The Red Flags The CRA is watching every TFSA holder

The Tax-Free Savings Account (TFSA) was introduced in 2009 to encourage Canadians to improve their savings habits by offering tax benefits. The tax-sheltered account, if used properly, allows you to earn a return on your assets in the account without having to pay taxes. However, the power it can give you for your long-term financial goals comes with responsibilities that you shouldn’t forget.

The benefits of a TFSA are excellent. You receive tax-free growth on the assets you have in the account. You have complete flexibility when you want to contribute to the account and the amount you want to withdraw at any time. The Canada Revenue Agency (CRA) does not collect taxes on interest income, capital gains or… dividend income from assets in the account, as long as you follow the rules.

Let’s say you like the tax-free nature of the account and decide it’s a good idea to run a business with it. In that case, the CRA may reclassify your TFSA profits as business income that they can tax. You may lose the tax-protected status of your account. Here are the biggest ways TFSA abuse can get you in trouble.

Day trading using the account

The account’s tax-free status means many people consider it more than just a savings account. I think it’s a mistake to call it a TFSA because the account can work well as an investment vehicle. Instead of generating interest income from cash held in the TFSA, you can build a stock portfolio that can increase in value over time without incurring taxes.

Unfortunately, using the account for frequent trading can get you into trouble. If the CRA finds that you are day trading with your TFSA, it may consider the earnings as taxable business income. There is no clear number of transactions per day that could trigger a CRA investigation, but it’s better to play it safe and focus on long-term investments in the account.

Investing in penny stocks

Using the TFSA for day trading is a clear violation that could jeopardize a TFSA’s tax-exempt status. It’s also important to remember one other important thing about a TFSA: Just as the CRA won’t tax you on capital gains for assets in the account, you can’t deduct capital losses from assets in the account from your returns. This means that using the account to hold speculative penny stocks can also be harmful.

Using the TFSA to hold penny stocks is not against the rules, but it could attract unnecessary attention from the CRA. Penny stocks can lead to significant losses, but they also deliver tenfold returns. The more aggressively you bet on penny stocks in a TFSA, the more likely the CRA will investigate further to see if you’re treating it as a business account.

Silly takeaway

Day trading and speculative transactions can be risky. However, you can benefit from using the TFSA with a long-term investment strategy. You can identify and hold high-quality investments that can deliver significant long-term returns. Fortis (TSX:FTS) could be one of the best holdings for this.

The utility with a market cap of $35.46 billion has several natural gas and electric utilities in Canada, the U.S. and the Caribbean. It generates predictable cash flows through its long-term contracted assets in interest rate regulated markets. The essential nature of its services gives it a defensive quality. No matter how bad the economy gets, people need natural gas and electricity. Providers like FTS are some of the last companies to worry about consumer cost-cutting.

Fortis has a long track record of paying dividends to investors and increasing payouts. At the time of writing, it is trading at $70.16 per share and paying investors $0.64 per share per quarter, which translates into a dividend yield of 3.65%. It can be an excellent long-term investment to consider for your TFSA.