There is nothing difficult about preparing a personal income tax return right? Just go to the store, buy a program and away you go. It’s easy. The software is 100% guaranteed right? Yes it is. It is guaranteed to do exactly what you tell it to do. But what if you do not know what you can claim as tax deductions or tax credits? Does the software know that you are now the caregiver for your elderly parents? Does the software know that you had a new addition to the family this year?
How about those medical expenses and the kids after-school activities, can you claim them? How much? Which receipts do you need to keep? How Long?
CRA loves it when people use ‘off the shelf’ software’, because people make mistakes. The average person does not know what they can and cannot claim and although the software may walk you through an interview process, it does not KNOW YOU.
What Prompts a Tax Audit?
For some, it is their greatest fear, for others, a fact of life. The letter from CRA saying they want to review your tax returns.
There are only 2 ways that a taxpayer can be selected for an audit:
1. Random Change
2. Targeted Selection Process
We’ll ignore random chance and give you the details for the Targeted Selection Process (TSP).
The TSP is based upon risk factors; the CRA looks for those that are more likely to owe more taxes based upon some specific criteria and experience:
10% of randomly selected taxpayers face an additional tax bill of more than $5,000 while 35% of TSP taxpayers owe more than $5,000 in additional taxes.
Filing online vs. paper filing has absolutely no bearing on being selected for an audit, what does matter though are:
1. Errors on tax returns; an occasional error is normal, multiple errors and repeated errors will get you an audit. 2. Self-Employment; taxpayers that are employed and have T4’s, RRSP Receipts etc. have a very low risk of being audited – CRA gets their tax information directly from the employers; mistakes are highly unlikely.
Individuals that are self-employed however, pose a much better opportunity for the CRA, especially those that are in cash oriented businesses (home renovations, contractors, etc.). Here are some interesting statistics from a CRA report to Parliament:
CRA conducted 366,260 audits in one year resulting in $2.5 Billion in additional taxes, interest and penalties. (small business audits) CRA conducted about 63,000 GST/HST audits in this same period resulting in assessments of more than $600 million.
They conducted 20,635 audits on ‘underground economy’ businesses – resulting in additional tax, interest and penalties of more than $284 million. 98% of tax evasion cases prosecuted by the CRA result in Convictions! And the rate of conviction has NEVER fallen below 94%
When it comes to your small business, what will trigger the CRA to consider an audit?
1. Major Changes in Income or Expenses; CRA likes things to be predictable, when things change dramatically, they will ask questions.
2. Repeated Losses; really? For how many years do you think your business can sustain losses before CRA will question it?
3. Expenses that are different than others in your industry; if you claim $10,000 in travel and all of your competitors don’t claim travel, CRA will question it.
4. Underreported Earnings; CRA conducts very detailed statistical analysis of businesses. If you are in a certain industry, they know what your margins should be; if you are way off, they will question it.
5. Large Charitable Donations; Your business is not doing well, but you donate $10,000 to charity? They will question it.
6. Home Office Deductions; There are very specific criteria required to claim home office expenses, if you don’t meet the criteria, they will come calling.
7. Discrepancies between GST Returns and Tax Returns; yes, they do check! If your revenues do not match or your expenses are not the same, they will question it.
8. Shareholder Loans; if the loans appear on your financial statements (as a receivable) for 2 consecutive years, expect a call! CRA does not like Shareholder loans that should be considered income and taxable.
9. Errors and Missing Information; If you get dividends, investment income, or rental income, CRA knows this. If you neglect to report it on your tax returns, they will call.
10. Divorce! – Yes, there is nothing worse than a disgruntled spouse. One call to CRA declaring that you have hidden income, over-reported expenses etc. will get you Audited!