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Posted by Tax Consultants

CRA Audit Red Flags

The chances of being audited or otherwise hearing from the CRA increase depending upon various factors, including whether you are reporting on time, the types of deductions, the business in which you’re engaged, and whether you own foreign assets. Although there’s no sure way to avoid a CRA audit, you should be aware some of the red flags that could increase your chances of drawing unwanted attention from the CRA:

1. Late filing on taxes

If you’re filing your returns late and/or have not filed for a number of years, it would be a sure bet that CRA will be knocking on your door, especially if there are taxes to be paid. The CRA has no problem waiting since interest and penalties accrue on a daily basis. Some reporting, like foreign income verification statements, must be submitted on time every year even if you don’t have any income to report, to avoid any penalties.

2. 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, especially if you’re self-employed and have received T-slips. A mismatch sends a red flag and causes the CRA computers to spit out a notice. In addition to any interests/penalties on any late taxes payable, CRA may automatically impose a federal 10% penalty on any unreported T-slip income in circumstances of a second case of an unreported amount in a three-year period. Most provinces also have a corresponding 10% penalty, thereby resulting in a 20% penalty for a second adjustment in a three-year period (for a first case of an unreported T-slip amount by a taxpayer, the CRA will automatically adjust the taxpayer’s personal income tax return). There is no minimum or maximum amount to which these penalties may be applied. 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.

3. Claiming large charitable deductionsMK & Associates

If your charitable deductions are unreasonably large compared with your income, it raises a red flag, especially if you have contributed to some tax shelter prompters that mainly help taxpayers avoid paying taxes.

CRA knows what the average charitable donation is for individuals at your income level. Make sure it’s a Canadian registered charity (can be checked on CRA’s website), and save all your official donation receipts made during the year. Unused claims may be carried forward for up to 5 years. Donations made to U.S. registered charities may be deductible if you have income from the U.S.

4. Claiming the home office deduction

This may be a tricky area as there has been great success by the CRA not accepting these home office expenses, and driving up the amount of taxes collected for the government. If you qualify, you can deduct a reasonable percentage of your rent, property taxes, utilities, internet and phone bills, insurance and other costs that are properly allocated to the home office. However, to be able to exercise this deduction, 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 rec room 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 personal use of the family.

5. Deducting business travel, meals and entertainmentmk apples2

Generally most underreporting of income and overstating of deductions are done by those who are self-employed.

CRA looks for large deductions on travel, meals and entertainment. A big write-off here will set off alarm bells, especially if the amount seems too high for the business. To qualify for meal or entertainment deductions, it must be business related and you must keep detailed receipts along with documents that provide the information on the people attending, the phone number of the client/s, and the business purpose. Without proper documentation, CRA may not accept these deductions and may in fact add interest and penalties on late payments of additional taxes payable.

6. Claiming business use of a vehicle

Another area that CRA reviews is the use of a business vehicle. When you deduct the expenses of a car, you have to provide what percentage of its use during the year was for business. Claiming unreasonable business use of a car is a red flag for CRA agents. They know that it’s extremely rare for an individual to use a vehicle for most of the time for business, especially if you have no other cars. CRA agents are trained to focus on this issue and will review your records in detail. Make sure you keep detailed logs and precise calendar entries for the purpose of every business meeting and related business activities. If you don’t keep a log book of these kilometers, it makes it easy for the CRA to disallow your deduction.

7. Claiming higher-than-average deductionsmk 4

If deductions on your return are unreasonably large compared with your income, or with large discrepancies from previous years, the CRA may tag 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.

8. Failing to report foreign assets or investments

CRA’s new reporting regime and tighter/higher technology when it comes to assets or investments over $100,000, is making it easier for them to keep an eye on monies and investments stored in tax havens or anywhere outside of Canada. Tax authorities have had success getting foreign banks to disclose account information.  The CRA has also used the voluntary disclosure program (VDP) to encourage individuals to come clean in exchange for no penalties and minimum interest.