An income tax audit is everyone’s worst nightmare. Whether you are filing business or personal taxes, the threat of an audit from the Canada Revenue Agency (CRA) hangs over everyone’s head. As a small business, your chances of getting audited increase significantly. The CRA keeps a close eye on the taxes of small businesses and self-employed individuals. Sometimes there is nothing you can do to avoid an audit as the CRA does audit businesses and individuals at random. However, there are a few red flags you can avoid, both as an individual, and a business owner, to decrease your risk of an audit.
Red Flag 1: Revenue Discrepancies
The revenue you declare on your income tax forms will be compared across all forms. You should take care to ensure that the number you declare matches the one on your HST tax return, your spouse’s taxes, and anything else submitted by your employer. If there are any discrepancies between these amounts, prepare yourself for an audit.
Red Flag 2: Being an Outlier
Being higher or lower than the norm in your industry draws immediate attention from the CRA. They have extensive information about average income and profit margins for every industry, so your business will be compared to those. Being an outlier means extra scrutiny from them and the potential of an audit. If your profits make you an outlier there is nothing you can do, but have all of your financial data and receipts prepared.
Red Flag 3: Deducting Large Business Expenses
When operating a business, one of the biggest advantages is the ability to deduct eligible business expenses from your income in order to reduce taxes payable. Make sure you are deducting the right, eligible, items by talking to your accountant. Advertising, meals, entertainment, travel and miscellaneous expenses are particularly interesting to the CRA, so again, make sure everything is accurate and approved to go on your tax forms by your accountant.
Red Flag 4: Claiming Home Office Deduction
Working out of a home office is great as you may qualify for tax deductions for amounts paid for rent, real estate taxes, utilities, insurance, phone bills and other expenses. In order to qualify for these deductions, however, you have to use the home office only to earn business income and regularly meet with clients, customers or patients. Most small businesses do not qualify or only partially qualify. An experienced Chartered Professional Accountant can advise whether or not you are eligible.
Red Flag 5: Business Use of a Vehicle
The biggest red flag for the CRA is claiming a vehicle for 100% business use. It is very rare for people to use a vehicle exclusively for business and the CRA knows this. It is even more of a red flag if you do not have another vehicle for personal use. Deducting this expense may make disallowing it extremely easy for the CRA, because most people do not keep the required records. Talk to your accountant about how to qualify for these deductions, and which records are required to keep as supporting documentation in case of an audit.
Red Flag 6: Running a Cash Intensive Business
Businesses that take in high levels of cash such as bars, restaurants, and hair salons are big targets for the CRA. The temptation to under-report taxable income and cash tips is high, so the CRA keeps a close eye on these businesses. If you run a cash intensive business, expect extra scrutiny and make sure you and your employees declare all taxable cash to avoid an audit.
Under-reporting cash based income can also raise a red flag. If the majority of your income is cash based, either from tips or pay, it can be tempting to withhold some of the amount from the CRA. The CRA has extensive information on how much each individual and business in various industries should be making, so under declaring can be a huge issue. If you are caught you will be forced to pay back-taxes as well as penalties and interest.
Red Flag 7: Mathematical Errors
Many tax returns are flagged by the CRA for basic mathematical errors or extra zeroes. To avoid this issue completely, have your personal or corporate taxes filed by a Chartered Professional Accountant rather than doing it yourself. Even the smallest error can raise eyebrows and draw unwanted attention.
Red Flag 8: Income Threshold
Unfortunately, there is not much an individual taxpayer can do about this one. If you earn more than $100,000 per year, then the chance of being audited increases significantly. The CRA tends to pay more attention to high earning individuals, so make sure to accurately report and keep records of all your financial data so that if an audit comes your way you are prepared.
When it comes to filing taxes the best policy is complete honesty and an experienced small business accountant. Inaccurately reporting, either on purpose, or by accident, can happen and the potential benefits are outweighed by the heavy penalties that come from a CRA audit. Meticulous bookkeeping, both for your business and personal expenses, will go a long way in keeping your taxes in order. Then, even if you are audited, you’ll have all of the necessary and accurate information prepared.