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How Your Business Can Avoid A Tax Audit

Getting audited by the Canada Revenue Agency (CRA) is something every entrepreneur dreads 😓. It’s a time-consuming, stressful and costly process.

While you can’t completely protect yourself from getting audited, these are some steps your business can take to avoid showing up on the CRA’s radar.

Account for All of Your Income

Make sure you report all of your business’s income when filling out Form T2125. A sudden decrease in revenue, or several years of loss, could trigger an audit. As long as you include all income, you don’t have much to worry about.

If you fail to report all of your income accurately, then the CRA will charge you 50 percent of the understated income or $100, whichever is greater. When the CRA catches the mistake, you will have to pay a penalty on top of taxes for the missing income.

Double-Check Your Returns

Go over your tax returns twice before sending them to the CRA. Missing even a single line on your tax forms will encourage the CRA to take a closer look at your business.

If possible, have another person look over your forms before you submit them. Fresh eyes may catch problems that you don’t see.

Maintain Organized Records

Keeping all of your business records organized will help you complete your tax forms accurately. Your records should include your business’s:

  • Receipts for expenses
  • Invoices
  • Credit card and bank statements
  • Payroll
  • Inventory
  • Previous tax returns
  • Quarterly tax filings and payments

Use software to keep electronic copies of these records, but don’t think that electronic records replace physical receipts and invoices. You still need physical copies in case you get audited.

Separate Your Personal and Business Expenses

Some business owners don’t do a good job of separating their personal and business expenses. This often leads to sloppy accounting that looks suspicious to tax auditors.

Easy ways to keep your personal and business expenses separate include:

  • Establishing a bank account for your business
  • Opening a credit card account for your business
  • Never borrowing money from your business
If you only take one action, get a separate bank account for your small business so your personal income doesn’t mix with your business revenue.

Stay Consistent With Your Accounting Method

Using a consistent accounting method makes your business look professional and helps the CRA review your records. If you switch accounting methods in the middle of the year, the CRA may want a closer look to make sure you reported all of your business’s income.

If you started the fiscal year using an accrual accounting method, then you should not switch to a cash method until the next year. In addition to helping you avoid a tax audit, following a consistent accounting method will make it easier for you to track your revenue and expenses.

Employee or Contractor?

If your business has employees and contractors, you need to know the differences between these two categories. As a general rule, a person is a general contractor if they:

  • Have control over how work gets completed
  • Owns the tools used to complete projects
  • Does not have to follow a schedule

The CRA will probably count someone as an employee if they don’t meet those criteria.

Mislabeling an employee or contractor can get your business in heaps of trouble. By using independent contractors, you can avoid several tax responsibilities, including contributions to the Canada Pension Plan.

If the CRA decides that someone on your list of contractors is actually an employee, then you will have to pay more taxes. Without a clear division between employees and contractors, you run the risk of getting inspected by the CRA.

These methods won’t just help you avoid a tax audit—it will help your business quickly deal with an audit if the CRA comes knocking.

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