How to Defend Yourself During a Tax Audit

By Markets Fool.com

If you're like most Americans, one of your worst fears is having yourtax return auditedby the IRS. In 2014, the IRS audited nearly1.4 million tax returns, and almost 1.7 million notices were sent to taxpayers for 2.2 million math errors identified on their individual income tax returns.

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Good record-keeping and organized documents are crucial to protecting yourself in the case of anaudit.The trick is knowing what to keep, where to keep it, and for how long.

What is an audit?
A tax audit is a review and examination of your accounts and financial information, per the IRS's audit definition. This process is performed to make sure your income, expenses, and credits have been reported correctly and in accordance with tax laws. The information you provide is used to verify that the amount of tax you reported is accurate.According to the IRS, tax-related documents shouldgenerally should be kept for three years from the date the tax return was filed.

How to defend yourself during the tax audit process
If you've been selected for an audit, the IRS will inform you in writing first. After the first written notification, you might also receive a phone call.Tax audits can be conducted in the form of an in-person interview and review of your records, but audits can also be conducted by mail.

During an IRS audit, your accounts and financial information will be reviewed and examined to ensure information -- income, expenses and credits -- is reported correctly and follows tax laws. They will also be checked to verify that the amount of tax you reported is correct.

During the tax audit process, you can defend yourself with the same financial information that is being reviewed and examined. Providing documentation for every aspect of your financials is the most critical action you can take to defend yourself.

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If your audit process happens in person, it might take place at an IRS office, or your home, place of business or accountant's office.You are entitled to certain rights during the audit process.

As outlined on the IRS website, your rights during an IRS audit include:

  • Professional and courteous treatment by IRS employees
  • Privacy and confidentiality about your tax matters
  • Knowledge about why the IRS is asking for information, how the IRS will use it and what will happen if you do not provide the requested information
  • Representation by yourself or an authorized representative
  • The option to appeal disagreements, both within the IRS and before the courts

There are three possible ways an audit can be concluded:

  1. No change: No changes result from the review and examination because you have provided evidence of all items.
  2. Agreed: The IRS proposes changes that you agree with.
  3. Disagreed: The IRS proposes changes that you do not agree with.

If you disagree with the audit findings, you might request further review by a manager. You can also exercise your right to file an appeal as necessary. To contact the agency for help at any time, call the IRS phone number:800-829-1040. You can also find detailed information and answers to your IRS questions atwww.IRS.gov.

Another option is get in touch with theTaxpayer Advocate Service(TAS), an independent organization within the IRS. The purpose of TAS is to protect taxpayers' rights and help you with tax problems you can't resolve yourself. Audits by mail and in-person audits are among their areas of expertise.

Documents you'll need to defend yourself during an audit
A key factor that will determine how well you defend yourself during an IRS audit is the amount and kinds of documentation and paperwork you have on file. "If a filer can have any and all tax-related documentation organized prior to completing his or her return, it will help to save time, stress, and uncertainty about the information being included," said Andrew Oswalt, certified financial planner and tax analyst for tax preparation software companyTaxAct.

Whether youbank onlineor receive hard copies of bank account statements, be sure to save these important documents:

  • Credit card and bank account statements:You might only need to save statements with notaxor other significant transactions for a year. One good idea is to download your detailed year-end bank account statements, if available, and keep those rather than multiple monthly statements.
  • Deposit, ATM, credit card and debit card receipts:Keep your receipts until you see that each transaction ison your bank account statement and isaccurate. Past that point, bank account statements are adequate records of transactions.
  • Payments made by check:Hang on indefinitely to checks written to pay for a home or fees associated with the sale of a home, renovations, or non-deductible contributions to an individual retirement account. Be sure to download and save any checks you've cut for charitable contributions, tax payments, and alimony and child support payments for at least the last seven years.

Banking and credit card statements aren't the only financial paperwork you might need to keep track of; depending on your situation, you might want to also keep the following:

  • Loan agreements:In addition to your home mortgage loan documents, you'll want to indefinitely save other agreements, such as those for second homes, personal and business loan documents, and carloans-- even if the note is paid off. The chances of being audited due to these loans are slim; however, you'll want to have your loan agreements just in case you have a loan dispute down the road.
  • Investment statements:Save proof ofstock and bond purchases, as well as retirement account contributions and withdrawals for at least seven years.

Types of tax returns that get selected for an audit
A few types of returns can signal the IRS that an audit is necessary. These include:

  • Returns showing very large gross incomes
  • Returns with Schedule C attachments, often based on the amount of deductions claimed in relation to gross business income
  • Returns showing significantcapital gain transactions
  • Returns failing to properly report all items of income
  • Returns missing required W-2s

However, being selected for an audit doesn't always mean that you've made an error on your tax return. According to IRS.gov, returns are selected for audit using a range of methods, including:

  • Random selection and computer screening: Returns are sometimes selected based only on a statistical formula.
  • Document matching: Payor records such as IRS Forms W-2 or 1099 that don't match the information reported might trigger an audit.
  • Related examinations: Some returns are selected for audit when they involve issues or transactions with other taxpayers -- such as business partners or investors -- whose returns were selected for audit.

How to prevent future audits
You can reduce your chances of getting audited by taking a few careful measures when you file your taxes. These tips might sound basic, but they can help you stay clear of IRS auditors:

1. Be honest
Be honest about all aspects of your tax return but especially regarding itemized deductions. If you are itemizing deductions, be truthful and accurate about your charitable contributions or donations, as well as your expenses.

2. Double check your math
"When completing a return, filers should double-check all information to ensure the numbers that were entered on the form match what was reported on the tax document or receipt," Oswalt said. "The IRS's automated system will detect any discrepancy, and unfortunately, theydo not know if it was a mistake or purposeful."

3. File your taxes electronically
E-filing and using the expert guidance of tax preparation software to file taxes can help you more easily navigate filling out your tax return and prevent mistakes or omissions. "E-filing a tax return continues to be the best way to lower the odds of beingaudited," said Oswalt. The IRS reported that the error rate for a paper return is as high as 21 percent; the error rate for returns filed electronically is just 0.05 percent.

4. Get professional tax help
If your taxes are more complicated than an average person's, then paying a professional to help you could be a worthwhile investment.

Remember, if you are notified that your tax return will be audited, it doesn't automatically mean bad news for you.Of the 1.2 million examinations of 2014 individual income tax returns, almost 40,000 resulted in additional refunds to the taxpayer -- resulting in $1.1 billion being refunded to taxpayers.

This article originally appeared on GOBankingRates.com.

The article How to Defend Yourself During a Tax Audit originally appeared on Fool.com.

ByRuth Sarreal.Anne Dullaghancontributed to the reporting for this article.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.