237. Why Sole Proprietors Get Audited: Common Triggers and How to Prepare – A Complete Guide by a Montreal CPA Firm Near You

Introduction

Sole proprietors—contractors, freelancers, consultants, tradespeople, gig workers, and home-based businesses—are among the most frequently audited taxpayers in Canada. Unlike employees, sole proprietors report their own income, deduct expenses freely, and often operate without strict bookkeeping systems. This creates a higher level of risk in CRA’s eyes. Understanding what triggers audits and how to prepare for them is essential to avoid costly reassessments, penalties, and interest. This guide explains the top audit triggers for sole proprietors and how to protect your business from CRA scrutiny.

Legal and Regulatory Framework

CRA audits sole proprietors under the Income Tax Act, the Excise Tax Act (for GST/HST), and the Tax Administration Act (Quebec). CRA verifies income, expenses, GST/HST or QST compliance, payroll obligations, T2125 business statements, vehicle claims, home office deductions, subcontractor payments, and bank deposits. CRA can expand audits to multiple years if records are incomplete or if misrepresentation is suspected. Sole proprietors must keep complete records for at least six years.

Key Court Decisions

In Mohiuddin v. Canada, CRA’s indirect audit methods were upheld after the taxpayer’s poor bookkeeping left income unverifiable. In LeBlanc v. Canada, CRA’s assumptions were overturned when the taxpayer provided complete documentation—showing how strong records can defeat an audit. In R. v. Ling, CRA’s use of bank deposit analysis for self-employed taxpayers was validated by the Supreme Court. These cases show that documentation—not luck—determines audit outcomes.

Top Audit Triggers for Sole Proprietors

1. Large or Unusual Expense Claims

High expenses relative to income signal risk. CRA focuses heavily on:

• Meals and entertainment (50% limit)

• Vehicle expenses

• Travel expenses

• Home office deductions

• Advertising and promotion

• Subcontractor payments
  Unreasonable or undocumented expenses trigger audits.

2. Cash-Based Businesses

Trades, barbers, tutors, mechanics, cleaners, and similar businesses often deal in cash. CRA aggressively audits cash industries.

3. Vehicle and Mileage Claims

Large vehicle deductions without mileage logs are one of the top audit triggers in Canada.

4. Home Office Claims

A home workspace must meet CRA’s strict criteria. Overstated or unsupported home office deductions trigger reviews.

5. Bank Deposits Exceeding Reported Income

CRA compares deposits to reported income. Any unexplained difference leads to audits, especially for sole proprietors without bookkeeping.

6. High-Payout Years

A sudden increase in income—even if legitimate—may trigger CRA review of source and accuracy.

7. GST/HST Inconsistencies

If GST/HST collected does not match reported sales, CRA suspects underreported revenue.

8. Multiple Years of Business Losses

Sole proprietors reporting losses over several years may face CRA’s “reasonable expectation of profit” test.

9. Real Estate and Assignment Sales

Sole proprietors involved in flipping, assignments, Airbnb rentals, or renovations often face business income reassessments.

10. Gig Economy Income

CRA receives data from platforms like Uber, Lyft, SkipTheDishes, DoorDash, Etsy, Upwork, and Airbnb. Unreported platform income triggers automatic audits.

Weaknesses CRA Looks for in Sole Proprietor Records

• Missing receipts

• Incomplete or recreated invoices

• Inconsistent bank records

• Personal vs business mixed spending

• No mileage logs

• Cash transactions without documentation

• Incorrect place-of-supply for GST/HST
  These issues cause CRA to assume undeclared income or deny deductions.

How to Prepare for a Sole Proprietor Audit

1. Maintain Clean Bookkeeping

Use accounting software such as QuickBooks or Xero and reconcile accounts monthly.

2. Keep Receipts for Every Expense

Digital copies are acceptable if legible.

3. Separate Business and Personal Finances

Have separate bank accounts and credit cards.

4. Track All Income (Including Cash)

Deposit cash into your business account before spending.

5. Keep Detailed Mileage Logs

A mileage app or spreadsheet is essential for vehicle deductions.

6. Document Subcontractor Relationships

Contracts, invoices, and payment records are required.

7. Keep GST/HST Records Organized

Store ITC invoices, sales records, and merchant processor reports.

What to Do if You Receive an Audit Letter

Respond immediately, gather requested documents, avoid giving excess information, and allow your CPA to handle all communication. Many audits escalate when sole proprietors attempt to explain without proper documentation.

Consequences of Failing a Sole Proprietor Audit

CRA may reassess:

• Unreported income

• Denied expenses

• GST/HST or QST owing

• Payroll reassessments for misclassified workers

• Gross negligence penalties

• Daily compounded interest
  These can be financially devastating if not addressed properly.

Mackisen Strategy

At Mackisen CPA Montreal, we defend sole proprietors with audit-ready bookkeeping, reconstruction of missing records, mileage recalculations, legal argumentation, and aggressive objection strategies. We ensure CRA receives clear, complete, and compliant documentation—and challenge incorrect assumptions at every stage.

Real Client Experience

A Montreal contractor avoided a $90,000 reassessment after we reconstructed three years of deposits. A photographer passed a vehicle audit through our mileage documentation strategy. A home-based consultant reversed CRA’s denial of home office expenses. A gig worker avoided penalties after we proved accurate income reporting.

Common Questions

Are sole proprietors more likely to be audited? Yes. Can CRA access my personal accounts? Yes—if they suspect income omissions. Does cash income trigger audits? Yes if not reported. Can I fix my records before CRA audits me? Yes—and highly recommended.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal protects sole proprietors from aggressive CRA scrutiny by strengthening bookkeeping, defending deductions, and challenging CRA’s assumptions with expert precision.