'Tis the season for "tax pain" in Canada. I love that TV commercial promoting tax preparation (OK loved it the first couple of times and now is annoying) which promotes A quick overview of what to do to avoid being audited.
Evelyn Jacks is president of the Knowledge Bureau, www.knowledgebureau.com, a national institute providing excellence in financial education for tax and financial advisors and their clients. She is author of many books on tax, personal finance, and wealth management, including Essential Tax Facts.
I have seen grown men tremble, mothers lose sleep and business owners pale at the thought: the tax man cometh. Hiding in the closet won't help; neither will filing the audit envelop at the bottom of the deepest kitchen drawer, or worse, File G. I have seen it done, all to no avail. It will happen to all of us at some time, so a coping strategy for audit selection is always required.
The best defence? File an a tax return that will stand up to the toughest audit, know your appeal rights and use them with the right advocacy team.
FILE AN AUDIT-PROOF RETURN: Now is the right time to make sure you have all the backup documentation for every figure on the tax return you are filing. A big secret to dealing with the taxman: retrieval is everything! You are required to keep your tax records (both soft and hard copy) for a minimum of six years.
It's not unusual for the CRA to request records for the current tax year and two years back. The whole process usually starts with a letter, but the auditors can also contact you in person. Ask for the letter before you begin, so you know exactly what they are looking for, the time frames and set up some time for them to come back.
You can request an extension to their proposed time frame, but if you do, make sure you meet the deadline.
There are certain provisions that are routinely audited. On the income-reporting side, expect four lines to be of particular interest:
• Line 126, Rental income
• Line 127, Taxable capital gains
• Line 128, Support payments received
• Line 135 to 143, Self-employment income.
There are no surprises here: tax-audit frequency is higher in those areas.
For average Canadian employees and pensioners, it's the deductions from total income that are of most interest to the taxman. Expect to be asked to verify claims for Registered Retirement Savings Plan deductions, particularly if there has been an excess or over-contribution to the plan.
Moving expenses, child care, employment expenses claimed by commission sales people or long distance truckers, business investment losses and the investment carrying charges claimed by investors — all are favourite targets for verification.
Investors should also be on high audit alert for the right documentation when they claim exploration and development expenses, security options deductions, losses of all kinds including capital, non-capital and limited partnership losses and, of course, the capital gains deduction.
Several non-refundable tax credit claims are easy targets, as well. Common requests for verification occur for high tuition fees claimed for young adults studying in Canada and abroad. The sick, disabled, or their caregivers, should know that claims for the lucrative disability amount, medical expenses and large charitable donations, can often be checked as well.
And here's a big audit tip for hopeless hoarders: store those tax records in a high, safe and dry place; the box marked prominently with the current tax year (2010 Returns), pristinely sorted documents within. Recreating what happened years from now can be extremely time consuming and stressful, and you want to avoid a net worth assessment at all costs. (That's when the taxman tells you what he thinks your income and deductions and credits should be, leaving you to prove otherwise.)
It's not unusual for a full-blown audit to happen right in your home or at your business premises. Be nice. Make it easy to find the bathroom. But, despite your best behaviour, what happens if you just run into a grumpy taxman? If he or she is just not seeing things your way, what's the process for challenging resulting adjustments to your return?
Know your appeal rights: Canada's tax system is based on those principles of self-assessment and voluntary compliance, and to be honest, it works well. You have the right to arrange your affairs within the framework of the law to pay the least taxes legally possible. But, if required, know that your appeal rights include negotiation at a local level with an appeals officer, and either an informal or a formal trip into the court system.
When you're a model tax-filing citizen; that is, you file your returns on time, and voluntarily tell the taxman about that unintentional overstatement of deductions or understatement of income — before he tells you — you'll avoid expensive penalties by using the Taxpayer Relief Provisions.
That's an important opportunity. This year, Canadians can correct errors and omissions to returns up to 10 years back (for the math-challenged among us, this means you'll have until Dec. 31, 2011, to correct or file 2001 tax returns.)
Leverage with the right advocates: The onus of proof is always on you first to show that you have “self assessed” properly. That can be tough for some, because, let's face it, taxes are complicated. What's more, you face several moving targets: constantly changing tax law, frequent changes in your personal life, and quite possibly, the testy relationship you could find yourself in with the auditor parked in your basement.
Either way, you're wise to invest in some tax knowledge, or get some knowledgeable help, especially when under the microscope. Make your professional dollars pay off — select an advisor who is an educator and who can set you straight. If the errors on your tax return are yours, save yourself a lot of time and money and simply correct them, pay your bill and move on.
You'll need an audit expert, as well as a sharp tax technician, someone who knows the law and is a good negotiator, too. Ask lots of questions of your potential audit pro, including how many taxpayers he or she has represented to CRA. Remember, there is no such thing as a stupid tax question, and you should never feel intimidated to ask what's on your mind.
This is very important: All tax disputes begin with the filing of a Notice of Objection, if your requests for adjustment on an informal basis fail. Do so within the required time frames. That puts your “taxes in dispute” and stops collection activities. It also preserves your rights to go on through the appeal system. Your Notice of Assessment or Reassessment is an important document. Since all timelines are based on the dates on these notices, don't misplace them.
A professional team you trust is especially important when you've caught the taxman's eye. You're on the defensive, you may be emotional, and an impartial third party who has gone through the audit routine many times can ease your pain. Your pro is your advocate, your voice of reason, and should know the process and the law well. Work with your team to get the results you need.
Additional Resources:
• What You Should Know About Audits: www.cra-arc.gc.ca/E/pub/tg/rc4188/rc4188-10e.pdf
• Essential Tax Facts, Part 2, by Evelyn Jacks www.knowledgebureau.com/Books.asp?tab=Authors#REJ017
