Top reasons why a CRA might review or audit tax returns

Top reasons why a CRA might review or audit tax returns

A CRA generally does not require a lot of supporting documentation in the initial filing, so a review is often to validate the information that has been submitted. Reviews may require documentation dating back six years.Graham Hughes/The Canadian Press

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If the 2022 tax season is like most years, about three million Canadians will receive notice from the Canada Revenue Agency (CRA) that their income tax returns are being reviewed.

In most cases, the review will ask for supporting documents for a particular claim, deduction or income amount – but just getting Ottawa’s attention can set off alarm bells.

Karen Mezgala, co-founder and CEO of Money Coaches Canada Inc. In Vancouver, “don’t panic,” which often has to keep customers calm when their taxes are under review.

“If you receive any kind of letter or communication from a CRA, it can be annoying. Most people deal with taxes once a year and it can be a stressful time even if they don’t receive these letters.”

Money Coaches Canada charges a flat fee for financial advice that can include investment and tax planning, but Ms Mizgala says any qualified advisor should be able to help.

“Your financial planner, even if he doesn’t pay your taxes, knows a lot more about taxes than the average person because they may already have clients who have gone through similar situations,” she says.

Whether the taxpayer hires a specialist or not, Ms Mizgala says the onus is on the individual to respond within 30 days — even if they ask for more time.

“The worst thing you can do is ignore it,” she says. “Another bad thing is that you try to not be forthcoming. Be honest.”

In most cases, the worst that happens is that the TRA rejects a claim, it says, adding that it will reassess it and could impose interest fines.

Why CRA might conduct a review

The CRA generally does not require a lot of supporting documentation in the initial application, so it is often a review to validate the information submitted. Reviews may require documentation dating back six years.

“I always recommend my clients to get a large envelope at the beginning of the year and include any receipts,” she says, adding that they can’t have a lot of supporting documents.

“Anything you deduct or claim should be considered reasonable as far as the CRA is concerned because you always have to look at it as – what if there is a review?”

Reviews never target or exclude any category of taxpayer, according to the CRA. However, returns may be flagged if the information does not match information from external sources such as employers or financial institutions on tax receipts (employment or investment income). It can also be flagged if a file has a “compliance history”, or simply selected at random.

The CRA conducts most reviews according to an undisclosed scoring system that identifies the payouts with the “highest potential for inaccuracy”.

While the CRA chooses to keep its audit methodology confidential, Lorne Kuttner, a tax advisor at the Northwood Family Tax Office in Toronto, says first-time claims such as large charitable donations, medical expenses or childcare expenses tend to go unreported.

“Nearly 100 percent of the ex-spouse’s maintenance payments will be reviewed,” he says.

Kottner adds that the reviews are also triggered when taxable income is split between spouses, or for employees at businesses that often deal in cash, such as restaurants or home improvement.

“Industries with a lot of potential cash transactions are often reviewed by the TRA,” he says.

The difference between audit and audit

Comments tend to be easily resolvable, he says, but things get a lot more serious when the TRA audits your tax return. The CRA generally reserves the term “audit” for more in-depth reviews, which include a close examination of books and records.

According to the CRA, files are selected for auditing based on a “risk assessment,” which includes further excavation of the tax file’s past.

Mr. Kutner says audits are almost always required for self-employed individuals if there is a discrepancy between income and HST filings.

The spirited real estate market has also increased the number of checks on homeowners taking advantage of the principal capital gains exemption, which eliminates capital gains tax on home sale profits, provided the owner is headquartered.

“The CRA is looking to see if it’s really a principal residence. If not, is the person really in the business of flipping — buying and selling with the intent of making a profit — rather than holding it for the long term and eventually selling it in the future,” he says.

He adds that the frequency of real estate transactions plays a big role in motivating scrutiny.

“Most people don’t buy a house, they live in it for two or three months and sell it…etc,” he says.

Mr. Kuttner says landlords who are demanding rental income but still showing losses, could raise red flags for an audit.

“[The] The CRA recognizes that there may be rental losses in the early years when you make repairs or it takes a while to get to market but over a longer period of time they expect these losses to be profitable in the end, he says.

But the most difficult factor to scrutinize is what he calls “lifestyle discrepancy” – when an individual’s luxurious lifestyle is not consistent with the level of income they claim.

“In other words, if the individual’s lifestyle does not fit the information on the tax return,” says Mr. Kuttner.

The darker motivation behind the audit decision, he says, is what is popularly called the “slander line,” in which individuals can anonymously report those they suspect of not having access to their taxes.

“These reports come from people who are usually unhappy with you — an ex-husband, a disgruntled employee. It could be a neighbour,” he says.

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2022-05-18 08:50:00

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