Ten Ways to Reduce the Risk of a Canadian Tax Audit
What are the two most dreaded words in the English language? Okay — aside from root canal. For many it’s tax audit. Chances are if you’re reading this you’re looking for ways to reduce your risk of getting anything other than a thank-you note — called a Notice of Assessment in tax speak — from the CRA (Canada Revenue Agency).
If you do happen to receive something more than a Notice of Assessment in the mail — perhaps a request for more information — the first line of defence is to avoid breaking out in a sweat. You see, you should understand that there’s a difference between an audit and a request for more information — also called a verification procedure.
The CRA may ask to see confirmation of receipts that don’t have to be sent with your return, such as childcare expenses and tuition, but that’s not an audit. In fact, most individuals are never audited; they simply receive requests for additional information. Here are ten pointers to help you avoid becoming CRA’s next audit target.
Audit your own return
Make sure you double check your return before you send it in. Check first for mathematical accuracy. Make your life easy and use tax software or an online service to ensure your numbers add up properly. Also check you’ve included all relevant information, like your SIN (social insurance number) and address. Avoiding simple mistakes is the first step in keeping the CRA from reviewing your return more closely.
Report all your income
Make sure you’ve reported all your income, including interest and dividends from all your accounts. If you forgot something, you can be sure the taxman will eventually find it. You see, the CRA gets a copy of all the information slips you receive and they cross check them by computer to make sure everything is reported. One handy tip is to compare this year’s return to last year’s to ensure you haven’t missed anything.
Have a reasonable expectation of profit
Be careful if you run your own business and are reporting a loss on this year’s return. To claim these losses, you must be running your business with a reasonable expectation of profit. If not, these losses can be denied. The tax collector only flags your return the first year you report business losses, but if you continue to report losses for the next two or three years you should expect to hear from the CRA.
Avoiding recurring losses can be as easy as reducing your largest expense over time, which, if you own your own business, is usually interest expense. Pay down your loans as diligently as possible and prepare a forecast to be able to show the taxman how you expect to earn a profit. Oh and don’t try to claim the losses from your Shetland pony breeding hobby against your other income.
File your tax return
Some people argue that the only way to ensure your tax return doesn’t get audited is simply not to file a tax return at all. After all, the CRA can’t audit what isn’t there. In fact, every year CRA sends out countless letters to individuals asking that they file a return — proof the taxman knows who these people are.
Non-filers risk not only getting caught and getting hit with interest and penalties, but also going to jail. In addition, if the CRA has to ask you to file a return then they are guaranteed to take a closer look at it when you finally do. So make sure you file every year — ON TIME! And if you’ve been a non-filer in the past remember it’s never too late to make things right.
Be consistent with your expenses
Claims for expense deductions must be reasonable, and the expenses must be incurred to earn income. This means that claiming your personal expenses not only is a bad idea — it’s not allowed under our tax law. If you own your own business, make sure your expenses are consistent from year to year. Of course you must still be able to support expenses claimed, but a significant jump in meals and entertainment or travel costs may just catch the taxman’s eye.
Sounds simple enough, right? Well, those of you who are tempted to cheat should be aware that the taxman has ways of tracking you down. The CRA has identified industries that have, in the past, had a higher incidence of cheaters, including construction, subcontractors, unregistered vehicle sales, auto repair, direct sales, childcare, cleaning, and restaurants. If you’re in one of these industries don’t be offended by our comments. You’re probably above board with your tax filings! But not everyone is — and you’re more likely to hear from the CRA.
Some of you like to voice your opinions on blogs and various other online forums — and that’s fine. But be aware that the CRA may be paying attention to your online musings. If the taxman takes notice of your comments he may just check your tax filings to close the loop.
Think twice about taking cash under the table
Many people think that taking cash payments for services will get them out of paying tax. What the taxman doesn’t know won’t hurt him — right? Don’t be so sure. There is no shortage of Canadians who are willing to quietly report you for offering your services on a cash basis.
Learn from your mistakes
If you’re caught cheating, it’s almost guaranteed the CRA will look at that particular item again the next year. Suppose, for example, that you receive a request to substantiate your childcare expenses, and find that — by accident or design — you’ve overstated your expenses. You can be sure the CRA will ask you to submit your receipts the next time around — perhaps even for the next couple of years. The moral of the story? You have absolutely no excuse for getting caught making the same mistake twice.
Don’t give the taxman something to audit
Some tax returns have very little worth auditing. An employee with one T4 slip has less chance of being audited than a self-employed person with significant expenses. The CRA likes to flag the more risky items to get more bang, so to speak, for its time spent assessing.
Items such as losses from tax shelters, significant interest deductions, rental or business losses, and clergy residence deductions (believe it or not) have an increased likelihood of being flagged for an audit. These deductions may be legitimate, but if you choose to complicate your tax affairs by reporting deductions that can be higher risk be sure you have the information necessary to back up your claim — just in case the taxman comes knocking.
Keep your fingers crossed
Even if you do everything right on your returns you may be selected for an audit or receive a request for information because of just plain old bad luck. Each year the CRA selects taxpayers at random, and uses the results of these audits or requests to determine where people make the most mistakes and in which areas people most often cheat. So even if you’ve crossed all your t’s and dotted your i’s, you may still receive an unwelcome letter in the mail on CRA stationery. Don’t assume you’ve done anything wrong — just be sure you can prove you did it right.