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The Canada Revenue Agency (CRA) typically sends out about 30,000 letters a year letting Canadians know they are being audited. While that is only 0.1% of the tax paying population, you may be wondering what to do if it happens to you. CRA audits are seldom random. When verifying income on tax returns, they use tools like the risk-assessment system & the Matching Program. As a result, they know which tax returns to audit. You can reduce your audit risk by knowing some of the common audit triggers the CRA looks for.
Unusual Changes in Deductions or Credits
You increase your chances of an audit if you claim substantially more deductions in one year compared to previous years. An example would be a significant increase in medical claims or large charitable donations. This may trigger an audit however, as long as you have the receipts & supporting documents to back up your claim the audit should go in your favour.
Excessive Business Expense Claims
The CRA prefers to spend their time on high risk taxpayers. As a result, self-employed workers & small businesses are often their targets. There are not a lot of options to avoid audits when you are in this category. However, good practices are:
– Keep home office claims small, the office should not be 50% of your home
– Be careful with vehicle expense claims, claiming 100% will raise red flags
– Put aside 25-30% of your earnings so you have the funds to pay taxes when due
– Keep all receipts & supporting documents
– Work with a tax professional to ensure you claim appropriately
Repeated Losses From a Rental Property
You are allowed to write off losses from a rental property. However, if you repeatedly report losses, the CRA may want to look at your records. They assume you bought the property to earn money. If your losses are legitimate, you must be able to provide documents supporting them. If you rent to a family member for less than fair market value, you cannot claim losses. The CRA is especially interested to see what you’ve done to find renters & charging market rate rents.
Vehicle expenses are often based on an estimate of the percentage of time it is used for business. Few taxpayers keep actually keep logs of every business trip. Consequently, few taxpayers can prove to a CRA auditor a vehicle’s personal use versus business use. This is one area where it is easy for auditors to deny vehicle expenses & increase your reassessments. Keep detailed mileage logs to support your vehicle expense claims. If you’re into apps, see our blog: Some of Our Favorite Mileage Apps.
If you really want to catch the CRA’s attention, live a lifestyle that doesn’t match your income. For instance, you live in a $2 million dollar home, drive an expensive sports car, take several expensive vacations every year & report $40,000 on you tax return. Lifestyles out of sync with reported income raise red flags with the CRA. Be prepared to support your lifestyle with documented proof if the CRA comes auditing.
For more information on the actual audit process, the CRA has info on what you should know about audits.
Contact us & talk to our tax experts for more information on common audit triggers & ways to avoid them. As well as our Audit Shield coverage you can have while being our client.