How to Prepare for a Tax Audit

You just discovered that you’re being audited by the Canada Revenue Agency (CRA). Now what?

After the initial pang of dread, it’s important to remind yourself that being audited doesn’t mean you are in trouble. Audits are nothing to fear as long as you’ve been doing everything by the book. During an audit, the CRA will examine your financial records and transactions to verify that you have reported your income and expenses correctly and paid the appropriate amount of tax.

You may wonder, “Why did I get audited?”

Income tax returns are subject to both automated and human review. While some tax returns are randomly audited, others have qualities that trigger a deeper inspection. The CRA identifies audit contenders based on a risk assessment that considers factors such as the likelihood or frequency of errors, indications of non-compliance, and information from other sources.

For instance, if you are self-employed or work within the “cash economy” where money can be made under the table (restaurants, construction, etc.), you run a greater risk of being audited. Claiming unreasonable expenses, reporting losses year over year, forgetting T-Slips, and rounding out numbers in your tax returns are just a few more ways to raise red flags.

While a tax audit can be very stressful and time-consuming, there are some steps you can take to prepare and ensure it all goes smoothly.

Steps to Prepare for a Tax Audit

Confirm the due dates. After the CRA first contacts you with the details of the audit and what documents and information you need to provide, don’t delay – get back to them as soon as possible. You will want to confirm the date, time, and location of the audit. Audits can range from weeks to months, depending on their scope and complexity. Depending on the situation, some are performed on-site while others are completed at the CRA office. If you need more time to gather your records, ask for an extension.

Get everything in writing. The CRA auditor may ask about your business activities, income sources, expenses, and deductions. Ask them to put all their questions in writing so you can maintain a record of communication and avoid any frustrating misinterpretations. Keep your answers clear and concise to prevent room for misinterpretation.

Start with the basics. An income statement, balance sheet, and a trial balance for your business are all basic financial reports that show your revenues, expenses, assets, liabilities, and equity. These reports should be kept accurate and up-to-date at all times, whether you are being audited or not.

Get organized. During a tax audit, you will be asked for supporting documents that prove your income and expenses, such as invoices, receipts, bank statements, contracts, leases, etc. Organize these documents by category and date, and label them clearly. Be sure to keep copies of everything you provide to the auditor.

Cooperation is key. The CRA auditor is not your enemy. They are just doing their job, like anyone else. While audits are a nerve-wracking experience, don’t let your anxiety get the better of you. The CRA auditor will want to examine your books and records to determine whether any adjustments are required to your tax returns or benefit claims. It is in your best interest to cooperate with them and provide everything they need. Avoid arguing or hiding anything. If you disagree with something, express your concerns calmly and respectfully as you would expect them to do for you.

Seek professional help if needed. A tax audit can be complex and challenging, especially if you have a large or complicated business or if you are not familiar with tax laws and regulations. The good news is you don’t have to do it alone. If you feel overwhelmed or unsure about how to handle the process, then professional help from a qualified accountant, lawyer, or tax consultant can provide some instant stress relief. They will step in to help you prepare for the audit, review your records, communicate with the auditor, and represent you.

Review the audit results. After the audit is complete, the CRA auditor will issue a report that summarizes their findings and adjustments. Review this report carefully to ensure you understand everything. If you agree with the report, you can sign it and pay any additional taxes or penalties that may apply. If you disagree, you have the right to a second opinion from another CRA officer, or you can file an objection within 90 days to have the matter reviewed by an independent party.

Learn from the experience. A tax audit can be a valuable learning opportunity. You can use it to identify any errors or weaknesses in your accounting system, improve your record-keeping practices, and ensure that you are complying with tax laws and regulations more effectively. Use your audit as a kickstart to better financial habits that will reduce your chances of being audited again.

Have you been audited, or do you think your accounting and bookkeeping could use some professional guidance to avoid any audit in your future? We’d love to help!

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