Top 9 Ways to Avoid Small Business Audits
Owning a small business can be taxing enough without involving the Internal Revenue Service, so take care to avoid small-business audits.
Small-business owners, especially sole proprietors, are at special risk of being audited. This is because many self-employment incomes can be underreported.
The CRA increased its number of small-corporation audits by 145 percent from 2004 to 2005, and in 2006 issued a report in which it estimated that unpaid taxes topped $6.5 billion in 2001, with about 32 percent stemming from unreported business income.
In 2018 the new government of the day brought in a new audit called net worth audits, as such they have Federal authority to examine bank records back as far as 1970- Additionally the Mainframe computers of CRA received significant Upgrades to AI and Data mining to uncover inconsistencies in your both your personal tax and business tax files.
While many tax professionals say it is unlikely the CRA will come knocking at your door, "if you're the one, it's not a good place to be," says Barbara Weltman, author of Small Business Taxes 2019 After all, audits cost time and money – two things most small-business owners have in short supply.
This year more than ever, small businesses have had to shift and optimize. Make sure you are on the right track with your finances by keeping them organized, timely, and accurate. We have compiled these tips to help your business avoid an audit and to support you through one.
Tip # 1 Keep Excellent Records.
- Tax time is easier when you have records detailing income, expenses, debts and deductions. This professionalism will show on your returns. Less than 4 percent of sole proprietors are audited, according to Weltman, and the CRA questions only 3 percent of Canadians about their tax returns, the Canadian Federation of Independent Business reports. Still, the CFIB advises keeping records and receipts for at least seven years. 10 years is more completed- digital formats are ok too. We work with our clients often to help them digitize their documents for safe keeping. BONUS TIP: Make sure to keep a backup of your files and records.
Tip # 2 File Complete Forms
- CRA - Canada Revenue Agency is forced to take a second look if you leave parts of your schedules or returns blank. Double-check to make sure your documents are complete before submitting them. And don't forget to sign the forms. An accountant can help you look over your forms to make sure they are complete.
Tip # 3 Report All Income
- The government is particularly interested in whether the self-employed individual reports their full income, so be sure to properly list all earnings. Use the exact figures that appear on your T4a forms. "If you don't, the CRA computers are going to know it," Weltman warns. The IRS has also been on the alert for errors in Schedules 124 (bus income) Schedule 5018, the form used to report incomes from partnerships, Shell corporations and some trusts on individual tax forms. The government is more likely to investigate cash-based businesses, so make sure your accounting is tight if you own a restaurant, for example. Cash transactions of more than $10,000 need to be listed on separate tax Forms.
Tip # 4 Keep Accounting Consistent (year over year.) Accounting treatment and Small business GAAP (Generally Accepted Accounting Principles)
- Most small businesses with sales of under $5 million can choose one of two accounting methods: cash or accrual. The cash method reports income in the tax year it's received, while expenses are deducted in the tax year they are paid. You may be required to use the accrual method if you produce, sell or purchase merchandise. This method requires income to be reported in the tax year it is earned and expenses deducted in the tax year they are incurred. You need to first receive CRA approval if you change your accounting method. Switching accounting guidelines on your own or mixing the two nearly guarantees the CRA will take a hard look at your returns.
Tip # 5 - Employee VS Independent contractors
- The National Body of Accountants (CA’s CMA’S CPA’s ) warns that CRA is on the lookout for business owners who qualify employees as independent contractors. If you tell your freelancers when and where to work and don't use contracts, for example, the government might consider the workers employees and expect you to pay payroll taxes. This could amount to significant penalties and back tax assessments by Canada Revenue Agency. If you don't know wether to qualify your team as contractors or employees, seek professional help to ensure your records are correct.
Tip # 6 - Professional / Personal Expense Recording and classifications
- The CRA is strict about not mixing the personal and the professional when it comes to write-offs. To qualify for a home-office deduction, your kitchen table can't double as your desk. We advise taking a photograph of your workspace for tax purposes. You and your employees can use personal vehicles for business, but record when, where and why you used them, as well as the exact mileage. And it's fine to take the family to Florida while you attend a conference, but only your business expenses are deductible and must be recorded accurately. A personal portion of the expense must also be accounted for. We use apps to help us keep this information organized in an easy to access format.
Tip # 7 - Pay your tax dues on time. (Payroll, GST, Corporate Tax)
- Depending on how complex your taxes are, you may be required to pay corporate taxes on monthly installments or quarterly installments.
- Payroll Source deductions- even if you have no employees in 1 month the reporting must be completed, For payroll and GST accounts these accounts are Trust accounts, Money you collect on Behalf of the Federal government. So it is highly important to make the relevant payments on time.
Tip # 8 - Phone calls, information requests and Desk audits.
- Respond to CRA phone calls (always get the Agents ID # Name and Contact phone #) Letters and Information requests: Make sure you reply in writing by the given due dates. If letters are desk audits and ask for accounting reports , such as payroll wage report, or Detail GST collected-expense report, Provide the reports by the Filing due date. If you aren't sure how to respond or if the request is a scam, we can help you move forward!
Tip # 9 - Utilize An Accounting Professional to do your Business Taxes.
- Depending on how complex your taxes are, you may want to seek help in filing taxes for your small business. By using tax-advice resources, you'll have a better chance of submitting returns that won't raise red flags -- thus avoiding an audit. If you don't think you need a professional you can try using tax software. Depending on what you get, Price and complex operations. What are Red Flags? As your Accounting and Tax advisors normally the following list.
- Non Payment of Payroll taxes
- Non Payment of GST Owing
- Non Payment of Corporate taxes owing
- Filing Personal or Corporate Tax returns where year over year variances are more than 10 percent , Shareholder loans or capital accounts do not reconcile and other technical variances that Alarm CRA.
A: If in doubt of a transaction, you can submit a transaction to CRA for a ruling.
Once you get a ruling back, that is the final arbitrated decision and you must follow it.
For example: Not sure if a person is a contractor or Employee, submit the Subcontractor contract and CRA Review form- a ruling will be made and eliminates all doubts or misunderstandings.
B: Submit your business to a Pre-audit process- Ask Your Accountant if they provide such a service. The accountants at Analysis360° can assist with pre-audit assessments which will assist in the event an Independent audit is needed by a 3rd party Audit Accounting firm.
If you have any questions about your small businesses' finances, we are here to help! Please book a free consultation and we can walk you through the process and best practices.