Everywhere you look online you can find advice on how to avoid a Tax Audit. We have some information on our website too. But what are we really talking about when we say “Tax Audit”?
What is a Tax Audit?
How worried should you really be, and much will it cost you?
The most important thing to note is that when someone talks about a tax audit, they might be talking about a range of different tax investigations.
An “audit” could actually be a range of processes:
- A tax review (not a real audit)
- A tax desk audit (a real audit, via correspondence)
- A tax field audit (a real audit, in your workplace)
This article describes each kind of investigation, how worried you should be, how much it will cost you and what actually happens during a tax audit.
What is a Tax Review?
A Tax Review is usually no more than a simple request for further information. In CRA terms, a review does not mean you are being audited.
Basically, they have received your tax return and want you to send proof that you deserve the refund you have requested.
Now that basically everyone is filing their taxes electronically this kind of quick review is popping up more and more often.
The worst thing about a tax review is that they can happen months after you’ve sent your taxes and you’ve already packed away all of your records. (Officially, you could get a review at any time of the year.) It’s a pain to dig out all of the files and find the thing they’re requesting and (if you organize like I do) it could take a couple of hours of your time.
Should you worry?
Probably not. As long as you have proof of the deduction and your did you math right, this is a quick one to solve. On the agony scale you’re looking at a 3/10. Annoying, but quick and easy to solve.
PS. If you have an accountant (we recommend it!) it’s even quicker and easier. Just send them the review notice and they’ll take care of the rest.
What is a Tax Desk Audit?
Usually the honour of a true audit is reserved for business – small business owners, people with self-employed income, corporations or trusts.
A desk audit (otherwise known as an Office Audit) is a real audit.
The auditor will request any files or records they want to see to make a decisions about whether your taxes were filed correctly or incorrectly (hint: they’re hoping to find a mistake).
The bittersweet detail of the desk audit is that auditor doesn’t actually come to your place of business. They stay in their office, you stay in yours and you send the files they request.
You’ll have to find the records they request and then mail them or scan and upload them to submit them online.
What is a Tax Field Audit?
This is The Big One. The real deal. The one that makes your stomach jump into your throat.
That’s not to say that there’s anything to be afraid of. If you filed your taxes honestly and correctly, an audit will more than likely be a waste of everyone’s time and resources.
In this case, the auditor will come to your place of business.
They will go through your records and talk to your people to determine whether you have paid the right amount of tax.
What Happens During an Audit?
In either a Desk Audit or a Field Audit the auditor scrutinizes a few different things.
The auditor will examine books and records, documents, and information (collectively referred to as records) such as:
- information available to the CRA (such as tax returns previously filed, credit bureau searches, or property database information);
- your business records (such as ledgers, journals, invoices, receipts, contracts, and bank statements);
- your personal records (such as bank statements, mortgage documents, and credit card statements);
- the personal or business records of other individuals or entities not being audited (for example, a spouse, family members, corporations, partnerships, or a trust [settlor, beneficiary, and trustee]); and
- adjustments made by your bookkeeper or accountant to arrive at income for tax purposes
The most alarming thing in that block of text is this:
The CRA will examine your personal records, and the records of other people and entities that are not being audited.
They are going to inspect your personal accounts, your family’s accounts and your business partners.
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How Much Does a Tax Audit Cost?
That depends. There a few different costs involved.
Hopefully, it won’t cost you anything.
If you send your records yourself and the CRA doesn’t find any amounts owing, it won’t cost you a penny.
If they find that you owe more taxes, then you’ll obviously owe that amount. Depending on the error or omission, the amount you owe could be a couple hundred or a few thousand.
Worst Case Scenario – If you’ve been evading taxes for a long time you could be facing big, big penalties or criminal charges.
The hidden cost of an audit is in the Audit Defence.
We recommend that you never defend yourself in an audit (more about that later). Whenever you can, you should hire a tax professional. Your defence bills will start piling up, but you should consider it an investment to clear your name.
Pro tip: If you have Tax Investigation Insurance, your professional audit defence fees are covered.
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4 Other Things You Should Know About Tax Audits in Canada
1) They Take Time
How much time, you ask? Well, it depends.
Here’s the official statement:
The time it takes to complete a business audit varies. Factors that influence the time it takes include the state of the records, the size and complexity of the business, and potential delays for missing records.
Unofficially? Weeks. Sometimes months. If you appeal, it could be years. It really does depend, but we can say for sure that it isn’t quick.
2) You’ll Get Your Notice In The Mail, Or On The Phone (Or Both)
Even if you use a tax preparer (accountant or otherwise) who submitted your tax return on your behalf, you will still get the letter of investigation.
When you get a letter, you should notify the your tax preparer as soon as possible; he or she will have more insight into the cause of the review and will want to review your documents before you send anything to the CRA. They might also want to call the CRA on your behalf.
That leads us to our next point.
3) You Should Never Defend Yourself In An Audit.
We’re really serious about this one.
Even if its a desk audit and you never come face to face with the auditor, you should communicate through your accountant (or other tax specialist).
Because, tax auditors are trained to spot your mistakes. You should have someone on your side with just as much (or more) expertise.
The auditor is hoping for errors and omissions that could lead to a reassessment. Then you’ll end up paying more in taxes, interest charges and penalties.
Given what’s at stake (your money, your business) you should invest in the services of a trained professional.
This is where your biggest costs come from. Consider it an investment.
4) If They Find an Error, You’ll Owe Money
They will hand you a notice of assessment. At that time you have the option to pay up or appeal.
[wt_note title=”What is a Tax Appeal” align=”center”] When you disagree with an assessment, reassessment or determination made by the CRA you are entitled to appeal to the Tax Court of Canada or a superior court of a province. If you are successful, you will pay less, or no, additional taxes. [/wt_note]
It should go without saying that if you want to appeal, you should hire a professional to do that too.
So, now you know what people mean when they say are being audited.
Our fingers are crossed that it won’t happen to you, but chances are good that eventually you’ll get one of those brown envelopes in your mailbox.
When you get a brown envelope in the mail, the first thing you should do is call your accountant.
If you have tax investigation insurance, the second thing you should do is call us.