Any individual and business owner dreads the idea of receiving a letter from the Canada Revenue Agency (CRA) about being audited. While there is no guarantee you’ll avoid the eyes of the CRA, you can minimize your chances of being audited by the CRA by paying attention to these red flags.
What is an audit?
According to the CRA, audits ensure fairness in the tax system for anything. Although the majority of citizens comply with tax laws and processes in Canada, there might be a select few who try to play the system. During an audit, the CRA examines the books and records of taxpayers to confirm all obligations and laws are followed, and they have received benefits and refunds they are entitled to.
How are files chosen for auditing?
The CRA selects a file based on their risk assessment which includes “the likelihood or frequency of errors in tax returns” or “whether there are indications of non-compliance with tax obligations”.
Small business owners and self-employed individuals are more likely to be audited.
7 Signs for a CRA tax audit
1. Abornmal Tax Return
Tax returns are usually consistent year by year. Any inconsistencies or big changes in deductions or income will become red flags for the CRA. To avoid becoming an outlier, ensure you are always documenting any changes. Although it won’t prevent you from possibly being audited, at least you’ll be prepared in the off-chance you are.
2. Revenue Discrepancies
The CRA verifies the tax slips they receive with the individual tax returns. Revenue from income tax form will be compared against all tax forms including GST/HST tax return, your spouse’s tax return, and information provided by employers, banks, and any other third parties. If it doesn’t match and the CRA notices, they will reassess your return and audit you.
3. You make more or less than average
The CRA’s database contains extensive information about various industries from normal profit margins to average income. If your income is significantly higher or lower than the norm in your industry, you might draw the CRA’s attention.
4. Large and/or Unrealistic Deductions
Deductions are one way small business owners and self-employed individuals try to offset their income. The tax advantage of deductions is that you can lower your taxable income by writing off certain expenses. While the temptation may be to write off as much as possible, large expenses set the CRA on high alert. The CRA’s highest areas of interest for deductions are advertising and promotion, meals and entertainment, travel, miscellaneous, and interest expenses.
5. Claiming a Home Office Deduction
Similarly, trying to claim a percentage of your rent and property fees can signal an audit. The home office deduction has very specific requirements that not many small businesses qualify to receive. For one, the place must exclusively be used to earn business income and to regularly meet with customers. It’s recommended not to claim this deduction if you are not using your home office space only for business purposes. If you are claiming, be accurate in your estimation of the floor space your home office takes up.
6. Trying to write off 100% of Your Vehicle
You are able to use your car for your work, however, unless you own multiple vehicles, you more than likely use a portion of your vehicle for personal use. Writing off the full percentage of a vehicle expense may trigger an audit. Either claim a smaller portion or keep a logbook to claim motor vehicle expenses.
7. Hiding Cash income
You are required by law to report all cash you receive. Some individuals and businesses attempt to hide their true income by accepting cash. Although a cash transaction isn’t as easy to see as a credit card payment, the CRA is experienced in determining the likelihood that you are accepting cash but failing to report it. For example: if your lifestyle is more lavish than the income your make according to your tax return, this might result in an audit. Certain businesses are more likely to collect cash, such as restaurants, hair salons, bars, and retail businesses, and thus are under more scrutiny.
How to Minimize Your Chances of Being Audited by the CRA
The best way to minimize your chances of being audited is by keeping detailed records and being honest when completing your taxes. Although the desire is to lower your taxable income, there are ethical ways to do it. Always document your finances and keep your tax records and supporting documents for six years.