When tax season starts approaching each year, nothing strikes fear into the heart of Canadian tax payers like the thought of an audit from The Canada Revenue Agency (CRA). Almost everyone has heard whispered stories about friends, co-workers, or family members that have been audited and how stressful (and often expensive) the process was. While no one wants to be audited, it’s important to understand how and why the CRA audits particular people, how the audit works, and most importantly, how to avoid being audited at all.
Below we will cover 7 reasons the CRA will audit you, what an audit really means, what transpires during the process, and how to properly and accurately file your taxes to hopefully avoid an audit altogether.
7 Reasons the CRA Will Audit You
While the CRA may choose to audit you for any number of reasons, below are 7 potential problem areas that may trigger a CRA audit.
1. You are self-employed
While being self-employed has a number of benefits, it can also be a red flag when it comes to your taxes, especially if you work as a freelancer. If you work as a freelancer, your earnings haven’t been taxed yet, so you won’t have a T4 to show the government exactly how much you made and the taxes that were withheld. This lack of official documentation may lead the CRA to conduct an audit to be sure you are paying your proper share of taxes. Your best bet is to put aside roughly 30% of your freelance earnings in a separate account to ensure you have the funds to pay your tax bill.
2. Living beyond your means
If you are making a modest salary but live in a plush apartment and spend half the year on exotic beaches, the government may decide to delve deeper into your tax filings. While you are free to spend your money (or extend your credit) as you see fit, seemingly living far beyond your means is an easy way to trigger a CRA audit.
3. Excessive claims
In certain cases, your tax filing allows you to claim a percentage of your expenses for items including your car and your home (if they are partially used as a business expense). However, there are limits; you are only supposed to claim the percentage of funds or physical space that are actually used for your business. If you have a small office in a large home, attempting to claim the entirely of your rent or mortgage as a business expense will surely raise some eyebrows at the CRA.
4. Not reporting all of your income
It should go without saying, but you need to report all of your income on your annual tax filings. Your employers will create a T4 for you during tax season, and will also send a copy to the government. If you fail to report a source of income (no matter how small) that discrepancy can lead to a full CRA audit. T4 slips can be lost in the mail or sent to an old address of yours on file, so be diligent about tracking them down as early in the tax season as possible.
5. Big changes in your tax situation
While a lot can happen in a year, sweeping changes in your tax situation can lead to further scrutiny by the CRA. If you are suddenly claiming a vast set of new expenses or applying for a number of new tax credits, that can be seen as a red flag. However, perhaps you just learned more about your tax options or began using a new accountant; to avoid any issues, be sure to keep copies of all of your bills and paperwork should the CRA come knocking.
6. Running a cash business
Running a cash business (even a part time venture) will likely put you on the CRA’s radar. Running a cash business relies on you accurately reporting the business income, without the usual electronic paperwork the government can refer to. Without that backup, you need to diligently keep track of all of your transactions to prove that you have accurately reported all of your income and avoid an audit.
7. Standing out from the crowd
The CRA will look at your tax filing and measure it against a number of similar filings to look for discrepancies. They may look at other filings in your earnings bracket, your neighbours, and other members of your industry. For example, if you are reporting substantially less income than others in your field, that may lead the CRA to believe that something is amiss with your return.
Other Reasons the CRA May Audit You
Even with those 7 red flags in mind, there are still a number of other potential issues that might trigger a CRA audit.
Constant business losses: If you are continually reporting business losses year after year and using those losses to offset other amounts you owe, the CRA may step in and want to review your file.
Excessive rental losses: Similar to the situation above, if you purchased a rental property in order to supplement your income and are constantly reporting losses to offset your tax bill, the CRA may understandably want to see why your property has never turned a profit.
Large donations or gifts: While you can claim charitable donations or cash gifts, the amounts should be in line with your income. If the CRA notices you are donating large sums of money that don’t seem to line up with your income, that may be cause for them to conduct an audit of your file.
Excessive family salaries
There is nothing wrong with paying your spouse or family members for services, but you need to be careful; the amounts paid have to be in line with average rates for the service provided, and you need to keep meticulous records. If you are spending a large part of your income paying family members excessive wages in order to lower your tax bill, that’s a sure-fire way to trigger an audit from the CRA.
What is a Tax Audit?
A tax audit is essentially a detailed verification process conducted by The Canada Revenue Agency (CRA). If the CRA has reason to believe there is an issue with your tax filing, they may institute a tax audit on your file. They are looking for discrepancies or improper claims on your tax return.
In essence, a tax audit is an investigation into your complete financial picture. The auditor is looking for anything out of place, which can include everything from excessive home office expenses, large cash gifts, or indications that you have underreported your income.
How does the CRA choose whom to Audit?
While it may feel random (especially if you’re selected for an audit) the CRA chooses who to audit based on an internal risk assessment tool that looks for inaccuracies and discrepancies in tax filings. These can include anything from underreported earnings, excessive home office claims (an easy way to trigger an audit), and running a cash-based business, any of which can result in a CRA audit.
What happens during an Audit?
A CRA agent will contact you (by phone and/or mail) to notify you of your upcoming audit. An audit can take place at your home or at a CRA office. If the audit is set to take place at a CRA office, you will be responsible for bringing all of the necessary documentation with you. The agent will make copies of all of your documentation, so be sure your records are in order and legible when gathering everything together.
During the audit, the CRA agent will ask to see all of your tax-related paperwork for the period under question (which can go back several years). The agent can also ask to see your personal records as well as those of your family. The auditor will ask you questions about any of their potential concerns while they are reviewing your file. If you have organized records, you should be able to back up all of the information you have provided on your tax return.
Once the agent has completed the audit to their satisfaction (which can take anywhere from several hours to several days depending on the complexity of your file) they will make a decision about how to proceed further. The agent may then decide that your initial filing is fine as is, and the auditing process is over. However, they may also re-assess your filing and present you with an updated version, which may increase your amount owing.
When the audit is complete, you will receive an official document in the mail outlining the auditor’s assessment (either that your initial filing was correct, or a re-assessment with either a new amount owing or a refund due).
You do have some recourse if you disagree with the auditor’s findings. you have 30 days to appeal the new assessment with the CRA, where you can make your case. If you still can’t come to an agreement, there are a number of options available to you including filing an official objection to the CRA ruling.
How far back can the CRA Audit you?
The general rule is 6 years from the date of the tax year in which they apply. For example, if the tax year is 2021, then you may be asked to furnish records going back to 2016. But if you file your returns late, then you should consider the date of filing and not the tax year.
It is important to note that while this is the general rule, it may change from case to case. If, for example, the CRA suspects fraud, there is a chance they may go back even further.
Apart from keeping your tax records, it is best that you keep all invoices, receipts, cancelled cheques, or any documentation related to medical expenses, donations, childcare, etc., that you may have shown in your tax returns over the years.
How to file your taxes
Filing your taxes may seem complicated, but there are a number of options now that make the process easier than it has ever been.
If you haven’t already done so, be sure to create your online account via the My CRA Account portal. You will be able to access all of your official government tax forms (including your Notice of Assessment, which you will need to file your taxes).
Once you have your Notice of Assessment, your T4 slips, and copies of all of the expenses you are looking to claim, you can file your taxes using any of the methods below.
The fastest way to file your taxes is through the government’s online Netfile service. Once you have completed your tax return via a tax filing service (more on those below) you can simply upload the completed forms through the Netfile service. If you are signed up for direct deposit (which we highly recommend), filing with Netfile is also the quickest way to be paid if you have an amount owed to you.
Another option for those filing online is the CRA’s Auto-fill option. Since the government already has copies of your T4 and other relevant information to file your taxes in the system before your filing is due, you can save time by using the Auto-fill service with an authorized tax return software. Note that you will need to be registered for CRA’s My Account in order to take advantage of this time-saving service.
3. Physical mail
If you aren’t very tech savvy or simply prefer returning your file in a physical form, you can always send in your tax return by mail. Note that this may take much longer to process, especially during COVID. While we don’t recommend this method (your return may be lost in the mail or take much longer to get to), you can return your filing by mail to your nearest tax centre. Note that if it is your first time filing your taxes in Canada, you are required to submit them by mail.
Online Tax filing services
Tax filing software makes filing your taxes easier than ever. While many opt to hire a tax professional to do their taxes, tax filing software guides you through the process step-by-step and allows you to file your taxes quickly and securely. Below are a few of the most popular software services, all of which are certified by the CRA and authorized for use by Revenu Quebec.
TurboTax software is the most popular tax filing software in Canada. The service is completely free if you use the company’s online Turbo Tax Free service. The company also offers a paid service with additional features and guidance if you have a more complicated tax return.
Read the full TurboTax review.
Weathsimple Tax/ Simpletax
Previously known as Simpletax, Weathsimple Tax is another free tax filing service that is now a part of the popular investment app Weathsimple. One benefit of using Weathsimple Tax is that you can manage your investments, trades, and tax returns all through one system.
Read the full Wealthsimple Tax review.
In business for over 50 years, H&R Block is the most recognized name in tax filing. In addition to their physical locations, H&R Block also offers an online tax filing system, with a basic free model and a paid “deluxe” upgrade.
The Bottom Line
While the thought of a CRA audit is enough to keep any Canadian tax payer up at night, understanding how and why the CRA may audit someone is a powerful tool in avoiding a potential audit.
Keep detailed records of your expenses and income and try to be as accurate as possible when claiming expenses related to your home office and car, two areas the CRA is extra vigilant about. While there is no fool-proof way to avoid a CRA audit, filing your taxes accurately and truthfully is the best way to avoid getting into hot water with the CRA.
Frequently Asked Questions
While it is relatively rare, the CRA does audit individual tax payers. The likelihood of being audited also increases with your earnings. According to the Government of Canada, the “CRA chooses a file for an audit based on a risk assessment.” That risk assessment looks for irregularities in your tax filings, including an analysis of your past filings and potentially, similar filings from your neighbours or other residents in your tax bracket or type of business. Your best bet to avoid an audit is to only claim valid expenses and be truthful when applying percentages of a claimed expense. For example, if you only use your cell phone for a handful of business calls each month, claiming the full amount of your bill may lead an auditor to look more closely into your filing.
Being self-employed does not exclude you from potentially being audited by the CRA. In fact, it may actually increase your odds of being audited. That said, rather than being concerned about being audited, you should be prepared. Keep meticulous records, and if possible, use software like QuickBooks Self-Employed to keep track of your expenses and income. You should also be sure to claim all of your business expenses in order to lower your taxable income amount and demonstrate the full picture of your business. In addition to all direct expenses related to your business (equipment, travel, etc.) being self-employed also allows you to write off a percentage of your rent/mortgage, your vehicle, and your cell phone and internet bills, among other expenses. However, be prudent when claiming expenses and only claim the actual percentage of your expense that applies to your business. Writing off 100% of your car or apartment as a business expense may raise a red flag with the CRA and lead to an audit.
An unreasonable expense can include an item or service that isn’t applicable for a tax deduction, including personal expenses. For example, restaurant receipts or personal clothing cannot be claimed on your individual tax returns, and would be considered unreasonable expenses. An unreasonable expense can also refer to the percentage of an item or a service you are attempting to claim on your taxes. While you can claim certain expenses as an individual or as a self-employed worker, the amounts claimed have to be in line with the maximum allowed or the maximum percentage detailed for self-employed workers. Any claims that seem out of the ordinary or stand out in any way from other tax payers in your bracket or profession can potentially trigger an audit by the CRA.