Occasionally I get an email asking how the CRA decides who to audit and how they make their decisions. While the actual process of selecting which tax returns to audit is obviously not disclosed by CRA, there are a few factors that increase the chances of an audit being triggered.
Ways of Getting Audited
There are 2 ways to get audited by the CRA:(1) through random selection and (2) through targeted selection based on risk.
The random selection audits are completely left up to luck (bad luck) and are computer based. Their purpose is to verify that the return was done honestly and accurately. Since they are random, the results are mixed – with most returns being prepared accurately.
I had my personal tax return audited when I was in university and was asked for my tax slips. At the time I had some tuition slips and a very small T4 (from working over the summer holidays).
The targeted selection audits are for people who the CRA considers to be ‘high risk’. The results of these audits are larger recoveries because they target those who the CRA believes are at a higher risk of filing their return incorrectly.
High Risk vs. Low Risk
The large majority of tax payers have employment income (and the related T4 slip) and are considered lower risk. Most people don’t realize that the CRA likely knows about your employment income before you even file your return. Taxes are deducted at the source and the CRA has verified the income.
Same goes for investment income, since the CRA also receives a copy of any T5 slips for any investment income you may have received.
Each person’s risk factors are different but in general – the more deductions you have, the higher your risk is. Some examples of deductions may be tuition credits, medical expenses, child care, public transit costs, etc. Since CRA doesn’t get a copy of these receipts they automatically increase the risk of being audited.
Other factors that may increase the risks of being audited are:
– Major changes in income or expenses from the prior year
– Obvious errors or omissions on prior returns
– A business with repeated losses
– Unusual expenses in relation to your industry
– Large charitable donations
– Home office deductions
Being self employed increases the risk of being audited even further. The CRA has no record of the income to verify against, they have a vested interest in making their income as low as possible to avoid paying taxes, and the rules for deducting expenses for the self-employed are sometimes used incorrectly.
For these reasons, being self employed automatically increases the odds of being audited.
The Importance of Clean Records
When being audited by the CRA, it is very important that all records be kept of every single transaction. It’s in your own best interests to keep detailed records of your business to protect against any expenses being denied.
Ideally you should be able to back up every single line item in your return if you are self employed.
Conclusion: There are 2 ways to get audited by the CRA: a random audit and targeted audit based on risk. Being self-employed greatly increases the odds of being audited so it is important to keep all your receipts.
Other possible audit triggers are excessive expenses, a business with repeated losses, home office expenses and large charitable donations. It is important to always follow the law when filing your return and seek professional advice if you are unsure about anything.
Related: Will Your TFSA Be Audited?