The chances of being audited or otherwise hearing from the CRA increase depending upon various factors, including your income level, whether you omitted income, the types of deductions or losses you claimed, the business in which you’re engaged and whether you own foreign assets. Math errors may draw CRA inquiry, but they’ll rarely lead to a full-blown exam. Although there’s no sure way to avoid a CRA audit, you should be aware of red flags that could increase your chances of drawing unwanted attention from the CRA:
1. Failing to report all taxable income
The CRA gets copies of all T-slips you receive, so make sure you report all required income on your return. CRA computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the CRA computers to spit out a bill. If you receive a T-slip showing income that isn’t yours or listing incorrect income, get the issuer to file a correct form with the CRA.
2. Taking large charitable deductions
We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag. That’s because CRA computers know what the average charitable donation is for folks at your income level. Also, if you don’t get an appraisal for donations of valuable property, the chances of audit increase. Be sure to keep all your supporting documents, including receipts for cash and property contributions made during the year.
3. Claiming the home office deduction
Like robbing banks (because that’s where the money is), the CRA is drawn to returns that claim home office write-offs because it has found great success knocking down the deduction and driving up the amount of tax collected for the government. If you qualify, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That’s a great deal. However, to take this write-off, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children’s playroom as a home office, even if you also use the space to do your work. “Exclusive use” means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night. Don’t be afraid to take the home office deduction if you’re entitled to it. Risk of audit should not keep you from taking legitimate deductions. If you have it and can prove it, then use it.
History shows that most underreporting of income and overstating of deductions are done by those who are self-employed. And the CRA looks at both higher-grossing sole proprietorships and smaller ones.
Big deductions for meals, travel and entertainment are always ripe for audit. A large write-off here will set off alarm bells, especially if the amount seems too high for the business. Agents are on the lookout for personal meals or claims that don’t satisfy the rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, the place, the people attending, the business purpose and the nature of the discussion or meeting. Without proper documentation, your deduction is toast.
5. Claiming 100% business use of a vehicle
Another area ripe for CRA review is use of a business vehicle. When you depreciate a car, you have to list what percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for CRA agents. They know that it’s extremely rare for an individual to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use. CRA agents are trained to focus on this issue and will scrutinize your records. Make sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for the CRA to disallow your deduction
6. Running a cash business
Small business owners, especially those in cash-intensive businesses — think taxis, car washes, bars, hair salons, restaurants and the like — are a tempting target for CRA auditors. Experience shows that those who receive primarily cash are less likely to accurately report all of their taxable income. The CRA has a guide for agents to use when auditing cash-intensive businesses, telling how to interview owners and noting various indicators of unreported income.
7. Failing to report a foreign bank account
The CRA is intensely interested in people with offshore accounts, especially those in tax havens, and tax authorities have had success getting foreign banks to disclose account information. The CRA has also used voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean — in exchange for reduced/no penalties. The CRA has learned a lot from these programs and has collected a boatload of money.
Failure to report a foreign bank account can lead to severe penalties, and the CRA has made this issue a top priority. Make sure that if you have any such accounts, you properly report them when you file your return.
8. Taking higher-than-average deductions
If deductions on your return are disproportionately large compared with your income, the CRA may pull your return for review. But if you have the proper documentation for your deduction, don’t be afraid to claim it. There’s no reason to ever pay the CRA more tax than you actually owe.