Do you worry about getting audited? If you answered yes, you’re in the majority of small business owners (and humans for that matter). One of the most common questions heard at tax time is, “What are the chances that I will get audited on my tax return?”
While it’s true that small business owners, especially self-employed individuals, have the greatest chance of being audited by the Canadian Revenue Agency (CRA) — simply because their returns are more complex — it’s also true that very few businesses are actually audited.
No one can give you a guarantee that you won’t get audited, but we can tell you what the most common audit triggers are and how to avoid them. First, though, let’s look at what to expect if you do get audited and the three types of audits.
What to expect if you get audited
The CRA will notify you, either by mail, telephone or both, if they are going to audit you. If you receive a letter, don’t panic, just begin preparing a few items. Make sure you have a copy of your tax return and gather all documents that support everything you claimed on your return. Depending on your comfort level, it may be wise to have an accountant or tax expert present at the audit. Usually the auditor will come to your place of business, but in rare instances you may be required to go to the CRA’s office for the audit.
During the audit, the auditor will go through your records, including old tax returns, your business’ records, as well as your personal financial records. The auditor may also go through the records of other people related to your business (your spouse or your business partner for example). The auditor may ask your employees questions, but will discuss any issues they find with you. Feel free to also ask the auditor questions, or raise any concerns that you may have.
One of two things will happen when the audit is finished:
- The auditor will find that your assessment was correct and the audit will be closed. You’ll receive a letter stating this.
- The auditor will find that the return has to be reassessed (this can either mean you owe more taxes, or you paid too much and are entitled to a refund). You’ll receive a letter with the proposed reassessment and you’ll have 30 days to either agree or disagree with it. If you agree the reassessment will be applied. If you disagree you’re encouraged to discuss it with the auditor, or if necessary, the auditor’s team lead. If you’re still not in agreement, you can file an appeal.
What you can do to prevent an audit
There is no guaranteed way to prevent an audit of your tax return. However, there are ways you can reduce the chances your return gets selected by the CRA. Here are the top five suggestions for avoiding common audit triggers.
- Review your tax return thoroughly before you submit it, whether you prepare your own or hire an expert to file it for you. Double and triple checking can help avoid common errors that could raise a red flag. If you have prepared your own return, make sure that you have someone else review it to ensure there isn’t anything you missed.
- Be truthful. If you claim only what you can prove then you will have nothing to worry about during an audit. Everyone wants to minimize their taxes owing, but falsifying your return can come back to haunt you. There is always a chance when submitting a tax return that you will be audited, but by following these strategies, as well as having a tax expert accountant prepare your return, you can greatly decrease your odds of an audit.
- It is impossible to completely reduce the possibility of being audited, but there are ways you can reduce your risk. Filing as a sole proprietorship instead of as a corporation may put you at risk of being audited (though it does have other advantages)..
- Always separate personal data from business. Keeping separate records and separate bank accounts will ensure you are not mixing your income and expenses.
- Filing your taxes on time will also reduce your chances of being audited. Filing late will attract more attention to your return since it may have been rushed and incorrectly prepared.
Common flags that trigger an audit
Tax auditors look for red flags when reviewing returns, and these are some of the most common ones to avoid:
- Consecutive years of business loss will almost certainly draw attention. Yes the CRA understands most small businesses will have losses in the first few years. But if your business continues to accumulate losses, the CRA will start to assume you are sheltering profits. The chances that a business is still around after five years of consecutive losses is hard to imagine, which is why such a business is likely to get audited.
- High expense claims is another red flag. They will compare your expenses to other relative competitors in your sector. If your expenses are materially above your competitors, you will most surely be audited.
- The CRA will also take a close look at home office and motor vehicle expenses. These expenses can be manipulated in your favor fairly easily since they are based on estimations. This is why they will spend more resources auditing these specific areas of your business’ return.
- Large charitable donations are also a common trigger. Very few people or businesses give 30% of their income to charity.
The most effective way to reduce your chances of an audit is to have your return filed by an accountant or tax expert. They are trained in understanding the law and will be your best bet in avoiding a tax audit. Not sure where to find one? Thousands of FreshBooks certified accountants and bookkeepers are just a click away on the FreshMap. Find one that’s in your area today, and sleep a little easier at night knowing you’re in good hands.
About the Author: Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting, and income tax preparation services in the Greater Toronto Area.