How to prepare for a tax audit
MAHTAB SAGHAFI, Senior Tax Advisor
HOW TO PREPARE FOR A TAX AUDIT
Tax audit is an experience every business person hopes to avoid. If the CRA (Canada Revenue Agency) or RQ (Revenue Quebec) does pay your business a visit, however, understanding what an auditor might look for can make the difference between a minor inconvenience and a major hardship.
During a full-fledged audit, a CRA or RQ agent may look at several specific items in your tax return and business records, including:
The CRA/RQ will compare your bank statements and deposits to the income you reported. They will also review your invoices, sales records and receipts, along with your general ledger and other formal bookkeeping records. If you received gifts of money or an inheritance, keep records to document how much you received. Without proof, the CRA/RQ may classify these as income and tax them as such. They will also classify any exchange of goods or services in lieu of cash (such as barter transactions) as taxable income.
- Expenses and deductions
An auditor may compare cancelled checks; bills marked “paid,” bank statements, credit card statements, receipts for payment or charitable gifts, and other business records to the expenses and deductions you reported on your return. They may pay special attention to reported debts or business losses; charitable gifts; and travel, meal and entertainment expenses. Keep a log to substantiate travel, meal and entertainment expenses, and be sure to deduct only legitimate business expenses.
- Loans and interest
An auditor may review loan paperwork, deposits, bank statements, credit card statements, receipts and cancelled checks to verify that you used borrowed money only to cover business expenses. This is important, since you may deduct interest on business-related loans.
- Employee classifications
The CRA/RQ will review employee classifications on your return and check this data against time cards, job descriptions, benefit plans, invoices, cancelled checks, contracts and other business records. Auditors will pay particular attention to independent contractor classifications, since many firms improperly classify regular employees as contractors.
Auditors will examine cancelled checks, tax returns, deposits, business records and other forms to check for completeness, accuracy and timely filing. They will also review records documenting provincial, federal and social security withholding, Medicare taxes, advance earned-income credit, unemployment compensation and workers’ compensation premiums. The CRA/RQ will also examine salaries and bonuses paid to owners and officers of your business to be sure they are legitimate and within industry standards.
- Other records
An auditor can also inspect records from your tax preparer or accountant, bank or other financial institution, suppliers, and customers.
In addition to inspecting your business, an auditor may inspect your personal finances. The CRA/RQ may compare your current lifestyle with the income presented on your tax return to determine if they are compatible. An auditor may also talk with others who are knowledgeable about you and your financial situation.
For Tax Emergency Advices or any Pre-Audit help: