Has your tax return been flagged? Keep calm and respond: Dale Jackson

Over 3 million tax returns are flagged for reviews by the Canada Revenue Agency (CRA) each year. THE CANADIAN PRESS/Sean Kilpatrick

Over 3 million tax returns are flagged for reviews by the Canada Revenue Agency (CRA) each year.

The reasons vary but are generally triggered by an automated system that detects discrepancies in income or deductions from previous returns.

There should be no need to panic but it’s important to know what a review entails and how it is different from the next step: an “audit”.

You must respond when the CRA comes calling

In the case of a review, the CRA will request supporting documentation for a specific claim, deduction or income amount.

It usually does not require much supporting documentation in the initial filing, so the review is often just to validate the information that has been submitted.

Reviews could require documentation from as far back as six years.

The onus is on the individual tax filer to respond within 30 days; even if it’s a request for more time. At this point the most that can happen is a claim or deduction will be disallowed. Ignoring a review request is probably the second worse thing you can do.

The worse thing you can do is try to be less than forthcoming, according to tax experts. CRA agents have likely seen every trick in the book and it could result in an entire reassessment or penalties.

The methodology for reviews is secret. The CRA says it conducts most reviews according to an undisclosed scoring system that identifies returns with “the highest potential for inaccuracy”.

The CRA says it never targets or excludes any category of taxpayer. Returns could be flagged, however, if the information does not match the information from third party sources such as employers or financial institutions on T-slips (employment, pension benefits or investment income).

Returns can also be flagged for a review if the filer has a “compliance history”, or they can simply be selected at random, according the the CRA.

When a review turns into an audit

Reviews tend to be easily resolvable but things get more serious when the CRA audits a tax return. The CRA generally reserves the term “audit” for more in-depth reviews, which involve a closer examination of books and records.

According to the CRA, files are chosen for audits based on “risk assessment”, which includes more digging in the tax filer’s past.

An audit usually means you have to pay a certain amount back within 30 days before they start charging interest.

In severe circumstances they have the power to garnishee wages and seize assets.

In really severe cases there are jail terms if the government proves fraud.

Experts say audits are often prompted for self employed individuals who deal in cash, or if there is a discrepancy between income and HST filings.

The CRA has recently increased the number of audits on homeowners taking advantage of the principal residence capital gains exemption, which eliminates a capital gains tax on the profit of a home sale provided it is the owner’s principal residence.

Rules dealing with who qualifies for the exemption have been imposed recently to crack down on “flippers” who frequently buy and sell homes.

Experts say landlords who claim rental income but still show losses could also raise red flags for an audit.

But the audit trigger most difficult to quantify is termed “lifestyle incongruence”; when the lavish lifestyle of an individual is not consistent with the level of income they claim.

A darker motive behind a decision to audit is what is popularly termed a “snitchline”, where individuals (disgruntled employees, ex-spouses, jealous neighbours, as examples) can report those they suspect are cheating on their taxes anonymously.

It’s probably time to call in a pro

Whether it’s a review or an audit, a qualified financial advisor should be able to help because they have probably had clients in similar situations. If it’s beyond their expertise, they should be able to direct you toward a tax specialist in the area that concerns your matter.

On the bright side, a good tax specialist can sometimes find longer term tax savings by going back to past returns and discovering errors and omissions that will actually generate a refund.

Hiring tax pros could be costly, but not as costly as ignoring the CRA.