If you file taxes in both Canada and the US, you could be audited by either agency, or both. While CRA and IRS audits serve the same purpose (verifying that you reported correctly), the process, timelines, and consequences differ in important ways.

How audits get triggered

CRA uses a risk-scoring system to select returns for review. Common triggers include: large deductions relative to income, repeated losses from a business, inconsistencies between T4s/T5s and your reported income, and random selection.

The IRS uses a similar scoring system called the Discriminant Information Function (DIF). High DIF scores flag returns for review. Common triggers include: unreported income (the IRS matches W-2s and 1099s automatically), home office deductions, large charitable donations, and Schedule C businesses with high expenses.

Types of audits

CRA has several levels:

  • Processing Review: automated checks during assessment. CRA may adjust your return and send a reassessment.
  • Pre-Assessment Review: CRA holds your refund and asks for documents before assessing.
  • Matching Program: CRA compares your return to information slips from employers, banks, and other third parties.
  • Desk Audit: a CRA officer reviews specific items by mail or phone.
  • Field Audit: an auditor visits your home or business. This is the most serious and usually involves business returns.

IRS has three levels:

  • Correspondence Audit: the most common. The IRS mails you a letter asking for specific documents.
  • Office Audit: you are asked to bring records to a local IRS office.
  • Field Audit: an IRS agent comes to your home or business. Reserved for complex returns, businesses, and high-income individuals.

Timelines

CRA generally has three years from the date of your NOA to reassess your return (four years for corporations). For fraud or misrepresentation, there is no time limit.

The IRS has three years from the filing date (or due date, whichever is later). If you omitted more than 25% of your gross income, the window extends to six years. For fraud, there is no limit.

Penalties

CRA penalties for understatement: a 10% penalty on the amount of the understatement if CRA determines you were grossly negligent (plus 200% of the tax-related benefit for false statements).

IRS penalties: 20% accuracy-related penalty for negligence or substantial understatement (understating income by more than 10% or $5,000). Civil fraud penalty: 75% of the underpayment.

Cross-border complications

If CRA audits your Canadian return and changes your income, that change may affect your US return as well. For example, if CRA increases your business income, you may need to amend your US return to reflect the higher amount (and claim the additional Canadian tax as a Foreign Tax Credit). The same works in reverse.

This is where things get messy without professional help. The two returns are linked through the Foreign Tax Credit, and a change on one side can ripple through to the other.

How to prepare

  • Keep records for at least six years (covers both CRA’s and IRS’s normal assessment windows).
  • Separate personal and business expenses clearly.
  • Reconcile your reported income to your bank deposits.
  • If you are audited by one agency, review whether the same issue could affect your return in the other country.

L&R Accounting supports clients through both CRA and IRS audits. If you have been contacted by either agency, get in touch before you respond.

Geetha Srinivasan, CPA (Ontario), CPA (US)
L&R Accounting Services Ltd.