I recall my days working in a public accounting firm. We used to prepare time sheets to record the hours we worked on a client file. We'd classify our time by categories of activities. I can recall one particular activity category that always puzzled me: "Unknown Unproductive Time." There was one guy I worked with who, in the course of one year, racked up 637 hours of Unknown Unproductive Time. Not exactly a recipe for promotion to partner. This guy was known for wasting huge amounts of time.
Wasting time is also something of a sport for tax auditors. Now, I don't mean any disrespect to these employees of the taxman, but when we talk about time wasters, very few things sit as high on the list as the hours spent beside a tax auditor digging up information and answering questions. Today, I want to talk about how to avoid a tax audit.
1. Don't sweat the concept.
You should know that very few individual taxpayers will ever face an audit. If the Canada Revenue Agency contacts you about your tax return it's most likely going to be a simple request for more information – which is not the same thing as an audit. Audits are more commonly reserved for businesses (sole proprietors, or incorporated businesses). Audits are more involved and can be very time-consuming. A request for information is a normal part of life, particularly since filing a tax return electronically means most people are not sending in all the supporting documents when they file.
2. Assess your risk of an audit.
Over the course of time, the CRA has identified certain industries as being higher risk for tax evasion. Construction businesses, subcontractors, carpet installers, unregistered vehicle salespeople, auto mechanics, independent couriers, direct salespeople, jewellers and restaurant wait staff are all well-known targets for the CRA. If you work in one of these industries, be aware that you have to be extra careful to file properly and have supporting documentation for deductions and credits. Also, be aware that the CRA has set up a "snitch line" for others to call anonymously to report you if you're cheating.
3. Audit your own return.
I've always said that the most common mistakes on tax returns can be easily avoided. Be sure to do the math correctly on your tax return; tax software should make this task easy. Make sure you've accurately provided all relevant personal information such as your name, address, social insurance number and province of residence. If you miss the simple things, your tax return could be flagged for closer examination. Compare this year's return to last year's before you file, to see whether there are any big changes; this can help to identify errors made this year or last.
4. Have a reasonable expectation of profit.
If you're going to be reporting losses on your 2012 tax return from business, partnership or rental activities, be aware that showing losses for three or four years in a row will flag your tax return. The CRA will expect you to eventually show profits, or they might just deny your losses. The CRA may send a warning letter if you've reported losses too many years running – just to let you know that they are watching.
5. Watch for big changes.
The taxman likes consistency. If you have incurred expenses, particularly business expenses, that are significantly higher this year than in the past, without a corresponding increase in revenue, your tax return could be flagged. Or, if you claim certain types of expenses that you have not claimed in the past, the taxman could take notice. The costs that the taxman will notice most are those with a personal element to them, such as travel and entertainment, meals or even repairs and maintenance. Just make sure you have backup for the costs and can explain why they were incurred, or why they were incurred to earn income (if they are business expenses).
6. Learn from your mistakes.
If the taxman has found errors or omissions in your tax return in the past, you are more likely to be called on again to substantiate your claims. Be sure to avoid the same mistakes twice.
7. Note targeted expenses.
The CRA likes to pick on certain types of expenses. These can vary from year to year, but the following items are more prone to investigation by the taxman: Interest deductions, moving expenses, charitable donations and even clergy residence deductions. Claim these if they are legitimate, but be sure you understand the rules for claiming them and can provide receipts if asked.
Tim Cestnick is president and CEO of WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians. email@example.com