Two weeks ago, Adam Mayers the Personal Finance Editor of the Toronto Star wrote a column on 6 tips to steer clear of an income tax audit. The tips included suggestions from Henry Korenblum, a tax manager in Toronto with Crowe Soberman LLP and yours truly.
I liked Adam’s idea so much, I decided to Dave Letterman it, and prepare a list of the top 10 ways to avoid a tax audit for personal income tax returns (except I will not work my way down from ten to one).
Before I present my list, I want to elaborate on Adam's comments on the difference between an information request and an audit, as I find many people are unclear about the distinction.
As Adam noted, these requests are typically innocuous. The CRA usually sends a letter asking for back-up information relating to a deduction or credit claimed on your return. Generally these requests are to provide support for items such as a donation tax credit, medical expense claim, support payment claim, a child care expense claim, a children's fitness tax credit claim or an interest expense claim. These requests are fairly common and more often than not, relate to personal income tax returns that were E-filed. Typically, once you provide the information requested, you do not hear anything further from the CRA.
An audit, which can take the form of a desk audit (which are typically undertaken to review an item that the CRA finds unusual in nature or specifically wants to review) or a full blown audit, are invasive and stressful and often result in a tax reassessment of some kind.
Top Ten Tips to Avoid a Personal Tax Audit
1. Avoid conflict (only being slightly sarcastic here). Many audits are triggered by a scorned spouse/lover, business partner you have had a falling out with or a dismissed employee. Many hostile divorce negotiations end quickly when one spouse tells the other they will be snitching to the CRA if they don’t get what they want. On the other hand, in acrimonious divorce negotiations, the threatened spouse often tells the "snitch" spouse to go ahead, since after the CRA takes everything they will get nothing. As you can see, these negotiations can get quite interesting to say the least.
2. File your return on time. Late filed returns often seem to pique the CRA’s interest.
3. Do not write explanatory notes or letters to the CRA with your return. I have often been referred new clients who had the crazy idea the CRA wanted to hear why they did or did not do something and created far larger problems for themselves by trying to explain away one issue, while creating multiple other issues. I always thought reading these letters would be the most amusing part of working for the CRA.
4. Unless you have a travel log to support your auto expenses, be reasonable in the percentage of business use you claim in respect of your auto expenses.
6. I know this is easier said than done, but if you are separated or divorced, try and agree in your separation agreement who will claim which expenses and which credits. Often both spouses claim the same children and same expenses on both returns. The CRA does not really appreciate duplicate claims.
7. Report foreign income, especially income from countries we exchange information with. Many people earn income in the U.S. or U.K. and do not report that income. The CRA exchanges information with both of these countries and they are like a “dog on a bone” once they realize you have not reported this income; plus the penalties can be very large.
8. Report the rental income attributable to the owner. For some unknown reason, many people seem to think the legal ownership of a rental property (and investment accounts) is irrelevant for tax purposes. I have seen several circumstances where spouses jointly own a rental property and they decide to just have the lower income spouse report 100% of the rental income (and often the spouse not reporting the income paid for the property). While this is often difficult for the CRA to find, they are not too impressed when they ask for a purchase and sale agreement and see that one of the legal owners has not reported any of the rental income or capital gains.
9. If you claim expenses as an employee, commission salesperson or self-employed business, do not claim personal expenses. I have seen people claim suits, dresses, nanny expenses (as administrative), facials, personal travel, etc. Claiming these expenses automatically casts a cloud over your honesty and auditors get their antennae up high.
10. File a departure tax return if you leave Canada. I have seen many situations where people move overseas or are transferred and do not file a final Canadian return, or file the return, but do not answer the question on the return about the date they left Canada. The CRA then keeps sending requests to file and often leads to an unnecessary review of their returns and residence.
I Guess Someone Other than my Mom is Reading this Blog
Over the last month, I have had over 21,000 unique visitors to The Blunt Bean Counter and over 75,000 page views; due in large part to my six-part series on "How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does!". I am very pleased that so many people found value in the retirement series! (The series is now in Flip Book form - link here.) I would like to thank my loyal blog followers and welcome the many new ones. I appreciate you reading my ramblings.
The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.
I never gave much thought to how income tax could affect divorce negotiations, sort of funny if you are not involved.
Anon, u dont know the 1/2 of it.Delete
Good morning Mark:ReplyDelete
Always be nice, that's half the battle.
Anyway, regarding rentals, if nothing else changes except interest expense and this is because of changing interest rates not the amount, any issues?
I have had a few people ask me this, and I say no, just keep the annual statement the financial institution sends you.
Usually, the most contentious issues regarding rentals is the apportionment rate (personal/rental %) and maintenance and repairs (always a fun area). These two elements can change the bottom line in a heart beat.
Happy tax season.
Yes, for interest I say the same thing, keep the annual statements. The issue is sometimes they use LOC and mix with personal, so tracking can also be important.
R&M are a fun area, my blog on the implications of a rental prop got so many questions on R&M and other related issues I stopped commenting. Definitely a contentious area.
I assume you r an accountant, so happy tax season to u.
Thanks for the reply Mark.ReplyDelete
I am an aspiring accountant....a few more months and I graduate with my Masters in Accountancy and then its off to law school (hopefully).
Always an avid reader of yours. Keep up the great work. There used to another great tax site from Prof. Ben Alaire from UofT but seems gone so this is the one site left where one can find many helpful pointers.
Regarding your trip out east, how about a trip out west, especially the Yukon in summer - truly a one of a kind experience.
Good luck, great combo accountancy and law. Actually I really want to go to the Yukon/NWT one summer.
Excellent blog. Congratulations on gaining new followers. Well deserved.ReplyDelete
Ramblings? Since when have you started rambling? Hmmm... gonna have to go back and reread some stuff to see if that is true! (grin)ReplyDelete
Anon, I guess you are just drawn to my pearls of wisdom and miss the ramblings :)Delete
Always enjoy your blog. This time of year I search back for your lists on preparation tips for the accountant.ReplyDelete
Weirdly enough, you seem like an old friend. Thanks for all your effort in sharing your knowledge.
Thx Pursuit and thank you for reading all these years, you must have been one of my initial readers way back when :)Delete