Audits 102: Everything self-employed people should know about audits.
June 17, 2022
You’re self-employed, hustling to make your own path and be your own boss. It takes hard work, dedication, and long hours. When the year is done, you get to take a look over the past 12 months of commitment to your business through the lens of filing your taxes, which are due June 15th of every year, to give the self-employed a bit more time to get everything in order. But then the Canada Revenue Agency (CRA) lets you know that you’re being audited. Don’t let that throw you off your game! You’ve got this, just like everything else. Let us walk you through being audited as a self-employed Canadian, and let us share some tips about how to avoid being audited in the first place.
Why might someone be audited?
There are a few things that the self-employed can do to trigger an audit.
- You’re self-employed. Hate to start the list off this way, but people who are self employed and don’t receive a T4 slip from an employer have a higher likelihood of getting audited, for a few reasons. One is that checking someone’s income against their work T4 is pretty easy – it either adds up or it doesn’t, so it’s harder to make mistakes or hide other income if a company is also sharing wage information with the CRA. Secondly, self employed income isn’t taxed at the source, meaning you're doing calculations on your own income and then paying the government what you think is your tax burden. It has more room for error.
- Your tax return is way more or way less than it was in previous years. For whatever reason, you’re claiming you earned more or less than you have in previous years running your business. It could be pandemic-related, supply chain related or just the amount of time you had available to dedicate to your business. Whatever the reason, if you know you’re filing for way more or less this year, just be prepared for an audit. See below about record keeping.
- In previous years, you’ve had tax returns with errors. If you’ve erred before, the CRA could suspect you’ll err again. There is a good chance you’ll be on a list for years to come, so be prepared in advance for that audit notice.
- Your claims seem excessive. Many people claim their home office or vehicle as a business expense, but if yours seems like it’s too high to make sense, the CRA will check into it. For example, you might have a dedicated home office and claim that space, which is usually based on square footage of the room compared to the house. If you’re claiming one floor of your house as the office, you’re likely to talk to the CRA. Or, if you are an Uber or SkiptheDishes driver, you’ll definitely claim car expenses. But if you claim 100% of your cars use as a business expense, the CRA is going to want to speak with you. It’s pretty rare that you’d only use your car for work and nothing else, you see? Anything they might find fishy, as compared to your previous filings or others in your situation is likely to raise questions.
- You are claiming losses from your business year after year which you are using to reduce income from other sources. If you are continually claiming business losses, the CRA will want to make sure your business is in fact a commercial enterprise.
- The CRA randomly checks a certain percentage of returns. You might just be an unlucky one!
What’s the first indication the CRA is auditing you?
An auditor will contact you by mail, phone or both. And – scam check – they won’t text you or email you. While we’re on the topic of scams, they also won’t ask you to pay with a gift card or cryptocurrency, so if you get a call like that, hang up. The CRA doesn’t use pressure tactics to get funds from you, and especially not before an audit takes place.
What does the auditor need?
The auditor may ask to do the audit at your office, home office or your representatives office. If not, they’ll conduct it at a field office. If the office is not in your region, they’ll ask you to send your documents in. Here’s where your expert record keeping comes in.
Ultimately, they want to see your records so they can ensure they match with what you put into your return. This could include seeing invoices, receipts, past years’ filings, credit history, property ownership information, spouse or common law partner’s return or anything else indicated on your return. Be patient, as the auditor might need further information or clarification from you.
Agree or disagree.
Once the auditor looks through your information, they’ll either confirm that your initial filing was correct, provide you with a letter of completion and close your file. If they find inaccuracies, they will file a notice of reassessment which will tell you how much more you owe – or how much your refund is increasing, though that’s an unlikely scenario. You don’t have to wait for this notice though; the auditor can tell you how much it will be so you can pay it without waiting.
And if you disagree with their findings, you can file an objection. But note that you will need to provide further documentation to prove your claim. You have the later of one year after the filing deadline for the tax return and 90 days from the mailing date of the Notice of Reassessment to file an objection. If your objection is disallowed, you can appeal to the Tax Court of Canada.
Tips to avoid being audited
Here are some things to keep in mind so that you can avoid being audited, or be insanely prepared for an audit should one arise.
- Excellent record keeping. All business owners know that they should keep their records, invoices, receipts and any other financials in clear and accessible order, and that the government requires you to keep these records for 6 years. But in practice, things might get busy, or might move around. There are excellent record keeping software products available to help manage. If you’re using electronic records and filing, ensure you have a backup hard drive or cloud storage in case anything happens to your tech. And if you’re using paper copies, we recommend backing them up on your computer as well, just in case.
- If you can avoid being a cash-based business, do that. If you’re a cash-based business in this day and age, the CRA is likely to take a closer look at your return. Reason being, cash is rare, and electronic point-of-sale is much more common. However, businesses like hair salons and restaurants are often cash-based or at least more balanced between cash, debit and credit payments. And though you may walk the straight and narrow line of the law, others before you have taken advantage of cash payments and not claimed total revenue, so the CRA is aware.
- Don’t have an unreasonable amount of family members on the payroll. Are your parents, spouse and children all accountants in your law firm? Are they really? It’s strange that your son Rick is both an accountant and a full time mechanic. If too many people in your family are paid and claimed employees of your business, and especially if they have other sources of income, the CRA might check in on that.
Tax audits might cause an initial panic, but it’s best to tackle it head on and get everything squared away in a timely manner to avoid any penalties. H&R Block offers Peace of Mind® Extended Service which can help filers if an audit pops up with both answering your questions and representing you to the CRA or Revenu Québec. And of course, if you need help filing your taxes, you can choose from one of four convenient ways to file: File in an Office, Drop-off at an Office, Remote Tax Expert, or Do It Yourself Tax Software.