How to Survive Your First Tax Audit
Updated: Mar 30
It’s officially tax season. For some, tax season brings joy in the form of returns, and for others – not so much. Where do you stand this year?
Maybe you’re not currently rounding up records for your tax returns – it all depends on your business type and fiscal year-end date. Either way, it’s crucial to be proactive with your records at all times of the year so that you’re ready for a tax audit should one occur.
The role of the Canada Revenue Agency (CRA) is an important one as it maintains the integrity of Canada’s tax system. A 2020 study written by Kenneth Klassen and Nick Pantaleo explained, “the prospect of being audited by CRA and any negative audit outcomes serve to encourage taxpayer compliance, particularly in a self-assessment tax system like the one in Canada.”
Understanding the tax audit process is the first step to minimizing the stress and anxiety surrounding what’s often seen as a negative process. We will explore the process to assist you in effectively preparing.
How Are Businesses Chosen for a Tax Audit?
The CRA may choose you to participate in a tax audit for various reasons. CRA performs a risk-based audit to determine which taxpayers are more likely to be non-compliant with tax rules. The risk determination may include:
the taxpayer’s history of compliance (for example, does the taxpayer have a history of making errors); or
the nature of the taxpayer’s operational activities that raises the risk of transactions being mischaracterized or mistreated for tax purposes (for example, taxpayers with international operations)
Not only do the above factors come into play, but you could also be one of the unlucky taxpayers that are randomly selected. You also want to keep in mind that having a change in deductions or credits (than in previous years) may flag your file, as well as having excessive home office expense claims. Also, the mere fact that you are self-employed increases your likelihood of being assessed.
What’s the Tax Audit Process?
The process is relatively straightforward if you’re selected for an audit.
You can expect:
To be contacted by a CRA auditor to start the audit process (either by mail, phone, or both).
The auditor will then advise you of the details of the audit, such as the time period in question and the documents required to satisfy the audit.
You would then submit the documents using the instructions provided by the auditor.
The auditor would then review the documents. The auditor will determine whether an adjustment is required.
If an adjustment is required, the auditor will provide you with a proposal letter. After receiving and reviewing the proposal letter, you have 30 days to respond if you disagree with the proposed adjustments.
After the audit is complete, you will receive a final letter by mail or electronically. The letter will state the audit results, including whether an adjustment will be made, whether a refund will be issued, or whether a payment is required.
What Does an Auditor Review?
The CRA auditor will review a variety of documents depending on the circumstances, some of which may include:
Business records (ledgers, journals, payroll records, etc.)
Personal records of the business owner (bank statements for personal accounts, mortgage documentation, credit card statements, etc.)
Personal or business records of other individuals or entities related to the business owner (spouse, family members, other corporations, etc.)
What if You Disagree With the Decision?
You can file an objection if you disagree with the assessment or reassessment results.An objection leads to an impartial review by the CRA.There are many types of objections, such as income tax objections, GST/HST objections, CPP objections, etc.
How Can I Proactively Prepare for a Tax Audit?
Although you may have never been subject to a tax audit, it’s important to ensure you’re prepared should you get a call.To prepare, ensure that you always keep your records and supporting documents for six years.
Be Proactive, and You’ll Be Prepared.
Although tax audits can bring about a lot of stress and anxiety on the taxpayer’s part, it is possible to feel more at ease in an audit situation. Feel more at ease by being prepared. Being informed is the first step. And now that you’re informed, it’s time to take action.
To get prepared, ensure to:
Keep your business records organized and available
Comply with all tax rules and legislation
Review your tax return to ensure its accurate
If you’re confident in your records and complying with all tax rules and regulations, you don’t have much to worry about. If you’ve done all the steps above and also understand the tax audit process, you may feel more at ease going through the audit process. After all, it’s a process like any other, and it will come to an end.
Throughout your fiscal year, there are many things you can control to feel as confident as possible with your business books. The most important is finding a reputable and knowledgeable professional to maintain your books and file your tax return. So, ask yourself now, have you found the right professional for you and your situation? If not, contact us today.