As a small business owner, professional, or freelancer, you don't want to draw unwanted attention from the Canada Revenue Agency (CRA). You have enough to do managing your business without undergoing a time-sucking and possibly expensive tax audit.
Certain red flags may draw the attention of CRA computers and auditors. Let's look at a few to see how you can avoid setting them off to avoid a tax audit. In all cases, honesty and accurate documentation are the best practices to follow.
Report accurate and reasonable expenses. If you claim amounts that appear too high, the CRA may wonder if you're padding your lifestyle expenses with your business expenses. A $200 business lunch may look suspicious; a $60 lunch is safer to claim. While it's easier to keep track of income, it's harder to keep track of expenses. With each purchase, label the receipt. Accuracy is your best defence in claiming reasonable expenses. When possible, automate to give you the most accurate records. In addition, you'll have proof. Consider getting an app, like one for a vehicle mileage record. It will help you to keep track of your vehicle mileage expenses, most likely an almost daily expense that you have to account for.
Avoid the easy temptation of trying to claim everything as a home office expense. Remember, you can only claim a dedicated space that you use more than 50 percent of the time for business. Your kitchen table? Probably not. The desk you use for work and also for surfing the internet to plan your next holiday. Probably not. Even claiming a spare bedroom or your den as a home office could trigger questions. Your kitchen table? Probably not. The desk you use for work and also for surfing the internet to plan your next holiday. Probably not. Even claiming a spare bedroom or your den as a home office could trigger questions. If you do have a dedicated space, figure out how much area it takes of the total area of your home. Claiming that you use 50 percent of your suburban townhome for business could raise the proverbial red flag.
According to the tax rules, driving between home and work is considered personal use. So you can't credibly claim that you use your personal vehicle 100 percent for your business. So how much do you actually use your car for legitimate business use? Keeping careful records answers the question. For every trip, note the date, destination, and purpose. Better yet, get an automated vehicle mileage record to keep track of all that information. At tax filing time, a vehicle mileage record saves you time and eliminates frustration. Throughout the year it also reduces the daily annoyance of having to record every trip you take with your car.
If you keep reporting business losses, the CRA might consider that you are running a hobby, not a business. If your business is new, you may have a few bad years. But you'll need to prove that your business is legitimate with proper customers and income, even if that income doesn't cover those initial start-up costs.
Was that winter holiday to the Bahamas really for seeking business opportunities? You better have proof. The CRA wants to know whom you met with? Where? What did you discuss? Was that dinner a chance to network with legitimate business prospects? Or was it more to impress your friends? Record what you talked about and show some proof of what you presented.
Declare actual amounts. If you made $42,386.66, then report that amount - not $42,000 even. And check your figures. If you have to submit a correction after you file your income taxes, your error may cause someone to take a second look at your entire return.
The chances are relatively good that you won't get flagged for a tax audit. However, self-employed people are more likely to stray from proper reporting. It's no surprise that some types of businesses are more open to tax filing abuse and more easily enter the CRA's radar. Is your business on this list:
As a summary on how to lessen your chances of getting called in for a tax audit, keep these tips in mind:
At income tax filing time, remember this saying: Oh, what a tangled web we weave, when first we practice to deceive.