Tax season 2015: 10 ways to attract a CRA auditor's attention
Recurring losses from a rental property, large gains in your TFSA and big changes on your return are red flags
We all like to be noticed.
But there are times when it's best not to stand out from the crowd. One of those times is during tax-filing season.
Every year, however, some Canadians seem determined to attract the scrutiny of the Canada Revenue Agency and its army of auditors.
And every year, the CRA's spotlights are focused on people who have performed the income tax equivalent of waving a red flag in front of a bull. These taxpayers have painted metaphorical targets on their foreheads, stuck "audit me" signs to their backs and stood in front of the CRA's radar dishes. They have, in short, dared the tax department to come calling.
So, what are some of those attention-getting triggers?
Here are 10:
- Ignoring the CRA's requests for further information. So, the tax department has asked you to submit a receipt for that big moving or child-care expense you've claimed. Ignore them, you think. They'll go away. Well, no, they won't. "If the taxpayer does not respond on a timely basis or is unable to provide adequate support for a claim, the CRA will issue a reassessment, perhaps denying a claim completely or adjusting an income or expense figure based on the information on file," says Ernst & Young. Failure to respond to legitimate requests for information can also flag your returns for audits in future years.
- Large or unusual changes in deductions or credits. The CRA's computers like consistency. "Major changes in income or expenses or tax deductions from one year to the next will raise suspicion," warns Barrett Tax Law, "so do try to be consistent in your declarations."
- Claiming hefty home-office deductions. Trying to write off half of the costs of running your six-room house for your home-based business just invites CRA scrutiny. "To be able to exercise this deduction, you must use the space exclusively and regularly as your principal place of business," says accountant Marvin Khoshkhassal of Vancouver-based MK & Associates. "That makes it difficult to successfully claim a guest bedroom or rec room as a home office, even if you also use the space to do your work."
- Claiming 100 per cent business use of a vehicle. Claiming you don't ever use your company car for personal use is a real red flag for CRA auditors since even driving from home to the workplace is considered personal use. PricewaterhouseCoopers points out that the CRA wants to ensure that "employees do not receive personal benefits tax-free, when salary, bonus and other forms of compensation would give rise to income tax." So, detailed record-keeping is essential when using an employer-supplied vehicle.
- Not reporting income from a T-slip. The CRA's system of matching the T-slip you're sent with the one sent to the CRA by the employer or financial institution is better than ever. If there's a mismatch, the computers will catch it, and your return will be reassessed. A penalty can be imposed for not reporting the income. Do that twice in a four-year period, and the penalties double.
- Reporting an income much lower than other residents in the same area. Reporting a $30,000 income in a neighbourhood of multi-millionaires just invites tax inquiries. "This suggests that an individual may have unreported income," say the tax lawyers at Gowlings in an advisory. "Unreasonably, low reported income is not only an audit trigger but may cause the CRA to initiate a so-called 'net worth' or arbitrary assessment, whereby various tools are deployed by the CRA to impute income to the taxpayer."
- Claiming an aggressive tax shelter. Tax shelters, which are designed to shelter income from tax that would otherwise be paid, aren't nearly as prevalent as they once were. And those that are still, in effect, face strict rules. "Taxpayers are not allowed to engage in aggressive tax planning arrangements deliberately designed to circumvent the object and spirit of tax laws," warns the CRA. So, RRSPs are fine. Gifting tax shelter arrangements, where taxpayers are given donation receipts that are for much higher amounts than the actual amount they donated, are not. Audits of these arrangements are guaranteed.
- Recurring losses from a rental property. You bought a rental property a few years ago, and it's still cash-flow negative. So, you're reporting a loss...again...which you plan to deduct against other income.
The CRA is quite aggressive in targeting rental loss deductions.- KPMG"The CRA is quite aggressive in targeting rental loss deductions," warns KPMG. So, you need to keep careful records that show you did your due diligence when buying the property and deciding on what rent to charge — and don't rent to a relative at a below-market price. The CRA knows that rental businesses, like all businesses, can take several years to turn a profit. But for losses to be allowed, there must be a reasonable expectation of profit down the line.
- Being self-employed. Having their own business can give some entrepreneurs the urge to over-report expenses and under-report revenues, and no one knows that better than the CRA. Working in an industry where cash frequently changes hands, like restaurants, can also up the odds of being given a fiscal cavity search. The tax department "has tools to investigate and gather information about your industry," says Barrett Tax Law. "If your numbers don't fit the typical profile, then chances are greater that you will be audited." The Canadian Federation of Independent Business echoes that warning in its publication, What to do when the tax auditor arrives. It says small businesses are usually chosen for audit for a specific reason. "Perhaps your travel and promotion expenses look high or your profit markup looks low."
- Having a large amount in a TFSA. Recent media reports say the CRA has been targeting holders of very large tax-free savings accounts (TFSAs) — those in the hundreds of thousands or even millions of dollars. The issue appears to be that some TFSA holders have been successful by being active traders within their TFSA, perhaps trading dozens of times a day. That appears to be a problem in the eyes of the CRA because taxpayers aren't supposed to use their TFSAs to carry on a business — in this case, a trading business. "It seems clear that the CRA is intent on challenging those who have enjoyed significant growth within their TFSA," warns tax law firm Thorsteinssons LLP. The tax department has reportedly been saying the gains in these cases should all be taxed. Look for this issue to head to court soon.
Most of the CRA's 144,013 audits and/or examinations in the last fiscal year didn't lead to criminal charges. But the tax scrutiny can still be costly and uncomfortable.
The good news is that there are steps you can take to minimize the fallout if you've done something wrong.
No. of voluntary disclosures made to the CRA in 2013-14: 14,624
Amount of previously unreported income disclosed: $813 million
The CRA's voluntary disclosures program allows taxpayers to 'fess up about something on their current or past tax returns that may not pass the smell test.
Doing this can prevent additional penalties from being assessed. But for the disclosure to be accepted, you must contact the CRA before it contacts you.
The CRA won't be in a forgiving mood if it's already on your doorstep.