CRA Audit trigger and how to avoid them

We understand that running a business and filing taxes on time can be a huge challenge. Amidst all this you certainly don’t want the special attention of the Canada Revenue Agency. A lot of people believe that if they have come under the audit, it is because of some bad fortune. But that’s not true. However, considering the CRA's standpoint, they receive an overwhelming number of tax filings, making it nearly impossible to audit each one individually. As a result, they employ filters to prioritize their audits and also incorporate random selections (referred to as the unlucky draw) to the mix.

Moving on to understanding what triggers CRA audits. By ensuring you file your taxes accurately and promptly, you can minimize the likelihood of being selected by the CRA's filters. If you happen to discover an error in your filings, it's advisable to proactively correct them by re-filing. The CRA acknowledges that mistakes can occur and values honesty. In this article, we will discuss strategies to avoid drawing the CRA's attention to your tax returns since undergoing an audit puts you directly under their scrutiny, leaving little margin for mistakes. Tax filings revolve around income and expenses, so any discrepancies that appear unusual might potentially trigger an audit.

The primary purpose of audits is to assess whether taxpayers have paid the appropriate amount of taxes. In the rare instances, if the Canada Revenue Agency (CRA) has reason to believe that a taxpayer may be engaged in fraudulent activities or deliberately attempting to avoid tax obligations, they may initiate a criminal investigation through their Criminal Investigations Program (CIP).

When does CRA audit a taxpayer?

An audit involves a comprehensive review of an individual's income tax return, often spanning multiple years of returns. The decision to conduct an audit is influenced by various factors, including –

• The frequency or likelihood of errors in tax returns
• Indications of non-compliance with tax payment obligations
• Information that appears inconsistent with other related files, audits, or investigations
• Non-compliance flagged by external sources or from other government investigations

The CRA may also choose to –

• Focus on auditing a specific group of businesses or individuals to improve compliance levels within that group
• Audit someone who has financial ties to an individual already under audit, such as business partners.

7 CRA audit triggers and how you can avoid them

Read on to know about the top 7 CRA audit triggers and how you can avoid them –

1. Overlooking reported income – a costly mistake in tax filing

It's never a wise decision to omit reporting your income from T-slips. Employers are required to issue T4 slips and provide a copy to the CRA for each employee. Failing to report all T4 income can attract the attention of the CRA. To prevent this oversight, ensure you keep a meticulous record of any transactions involving cash payments, and remember to include them when the time comes to file your taxes.

2. Reporting Abnormally High Credits or Deductions in Your Tax Filing

The CRA closely examines the consistency in tax returns, even for those who are self-employed or running small businesses. A significant and sudden increase in income, credits, or deductions within a particular year could trigger a review of your return. To prepare for any potential scrutiny from the CRA, maintaining clear and comprehensive documentation of all financial activities is crucial.

3. Don’t overpay salaries to family members

Paying salaries to family members, including yourself, can be a tax-efficient method to withdraw money from your business. However, it's essential to be aware that the CRA scrutinizes these payments, comparing them to prevailing market rates and your business records. Overpaying salaries to family members without proper documentation can potentially trigger an audit, leading to double taxation. The audit reassessment might disallow these salaries as legitimate business expenses, resulting in the salary recipients being liable for individual taxes on that income.

To avoid such issues, it is crucial to treat your spouse and children as you would any other employees. Follow the standard procedures for documenting their salaries, ensuring compliance with tax regulations. This way, you can confidently navigate the tax landscape and avoid unnecessary complications.

4. Not providing the correct information

If the CRA has inquiries or doubts regarding your tax return, they may issue a Request for Information. In such cases, it's essential to understand that resisting or ignoring the request won't be beneficial.

The most prudent course of action is to promptly and courteously provide the requested information. Doing so not only addresses their concerns but also helps prevent the situation from escalating into a full-fledged audit. Cooperation with the CRA can lead to a smoother resolution and averted complications.

5. Too much of home office deductions

Claiming a home office that occupies around 10% of your home's floor space appears justifiable. However, asserting a workspace taking up half of your six-bedroom house may raise eyebrows and could potentially invite an audit.

To ensure a smooth process, accurately calculate the percentage of your home utilized for your business or WFH office space. Be reasonable and adhere to the CRA's guidelines for home office deductions. By doing so, you can maintain credibility and avoid unnecessary scrutiny from the authorities.

6. Not having valid tax shelters

Legitimate tax shelters like RRSPs or TFSAs are entirely acceptable and won't draw any suspicion from the CRA. However, red flags are raised when the CRA encounters unfamiliar non-profit organizations. This is because numerous audits are initiated annually due to fake non-profits with questionable receipts, notorious for inflating donation amounts.

To safeguard yourself before making a donation to your preferred cause, ensure it is listed as an official charity by the CRA. This step is particularly crucial if you plan to claim the donation against your taxable income. By adhering to this practice, you can confidently support legitimate charities and avoid any potential tax-related issues.

7. Not adhering to vehicle expenses and business deductions

Suppose you own a parking garage and acquire a snow plough; writing off the entire purchase as a business expense is less likely to attract attention from the CRA. On the contrary, attempting to claim 100% of the family sedan might raise doubts, as the CRA could question whether you solely use it for business purposes and not for personal activities like taking the kids to playdates and soccer practice. The key to handling vehicle-related expenses is to maintain accuracy and reasonableness. Follow the guidelines provided by the CRA to ensure smooth and credible deductions. By doing so, you can steer clear of any potential issues with the tax authorities.