Dealing with an Audit
The government uses audits as a way to ensure that the tax returns submitted are, in fact, accurate. They generally select files for several reasons: your return may have raised some questions; your partner may be being audited; information may have been received from a source that indicates there's a problem with your return; your type of business is being examined more closely, in general; or, in fact, it may be a completely random, luck-of-the-draw selection.
In some cases, you'll simply be asked to send in the receipts or documents that apply to a specific part of your return. Ensure that you make copies of those documents before sending them by registered mail before the deadline set out in the request.
In other cases, an auditor may visit your home-based business to conduct a thorough review of your records. This can be intimidating, and it will certainly be time-consuming. You'll likely need to familiarize the auditor with your business and possibly even with the industry that you're in.
Before the auditor's arrival, go through your records to make sure that they're as organized and complete as possible. You should also talk to your bookkeeper or accountant — they may be able to provide advice, and (although it may involve additional costs) even be present when the auditor visits if you feel you don't have the knowledge to deal with the auditor's questions on your own.
Whatever happens during the audit, remain calm, collected, and polite. Becoming argumentative or defensive isn't going to help, and it may well hinder your cause. Do your best to explain the issue to the auditor, but if you're not getting your message across, save your argument for the written appeals/objection stage of the process.
You'll later receive a letter detailing any changes to your tax return(s) that the auditor is recommending and the process that you can follow if you object to those changes. If you do want to object, it's definitely time to bring in some expert help.
In the worst case scenario, where you're facing an additional tax bill that you don't have the money to pay, you should be able to work out a payment arrangement with the IRS or CRA. You'll be charged interest on the outstanding amount, but that's better than being hit with penalties for nonpayment on top of everything else.