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Written by Tony Dong, MSc, CETF® at The Motley Fool Canada
Registered Retirement Savings Plan (RRSP) season for the first 60 days of 2026 has just wrapped up, and hopefully, you managed to stay within your contribution limits.
If you did accidentally overcontribute to your RRSP, the rules are fairly forgiving. There is a $2,000 lifetime cushion that allows you to exceed your limit without triggering immediate penalties, as long as you correct the issue.
The Tax-Free Savings Account (TFSA) is not nearly as lenient. Many Canadians assume that because the TFSA is “tax-free,” the Canada Revenue Agency does not pay much attention to what happens inside it. That is not the case.
The CRA keeps a close eye on these accounts, and there are several common mistakes that can trigger penalties, audits, or an unpleasant letter in the mail. Here are three of the biggest red flags TFSA holders should avoid.
The most common TFSA mistake is contributing more than your available room.
Unlike RRSPs, there is no $2,000 grace buffer. Even a small overcontribution can trigger penalties. The CRA charges a tax equal to 1% of the excess amount for every month it remains in the account.
Part of the confusion comes from how the TFSA room works. Contribution room accumulates each year, and withdrawals create new room, but only starting on January 1 of the following year. Many people withdraw money and redeposit it in the same year, not realizing they may have just created an overcontribution.
Checking your available room before contributing is one of the simplest ways to avoid this problem.
Another situation that surprises many investors involves U.S. dual citizens.
For Canadians, the TFSA is a tax-free account. But the United States does not recognize it as such. If you are a U.S. citizen or considered a U.S. taxpayer, the IRS may treat income inside your TFSA as fully taxable.
That means dividends, interest, and capital gains could all be reported and taxed by the United States IRS, even though they are tax-free in Canada and ignored by the CRA.
In addition, the reporting requirements for foreign financial accounts can be complex and burdensome. In some cases, holding certain investments inside a TFSA may create additional filing obligations.
Anyone with U.S. citizenship should speak with a cross-border tax specialist before opening a TFSA.
The third major red flag is using a TFSA for day trading.
The TFSA was designed as a long-term savings vehicle, not an active trading account. If the CRA determines that you are operating a business inside your TFSA, the income can lose its tax-free status.
There is no bright-line rule that defines exactly when investing becomes day trading. Instead, the CRA looks at several factors. These include how frequently you trade, how quickly positions are turned over, how much time you spend researching and executing trades, and whether you rely on trading as a source of income.
If the activity resembles a business, the CRA may classify your gains as business income. That means they can be fully taxable, defeating the main purpose of the TFSA.
For long-term investors who occasionally rebalance or adjust their portfolio, this is rarely a problem. But for people making dozens or hundreds of trades in a year, it can become a serious issue.TFSA overcontributions are penalized at 1% per month with no $2,000 grace buffer like the RRSP.
The post 3 Major Red Flags the CRA Is Watching for Every TFSA Holder appeared first on The Motley Fool Canada.
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