Although the IRS accepts most tax returns as filed, some returns are selected for examination or audit generally on a random basis.  The examination may or may not result in more tax. An examination may be closed without change or you may receive a refund.  If the IRS proposes to increase your tax, however, you have the right to appeal this decision both within the IRS and to the courts. Here are a few more details about the process.
Selection of Returns for Audit:  The IRS examines tax returns to verify the correctness of income, exemptions, credits, or deductions reported on the returns.  A computer program selects most returns that are examined.  The program evaluates selected entries on a return and gives the return a score. Returns are then screened by IRS personnel.  The returns that the IRS thinks have the highest probability of error are selected for examination.
The IRS tries to avoid repeat examinations of the same items.  Thus, if the IRS examined your tax return for the same items in either of the two previous years and proposed no change to the tax liability, you should notify the IRS and the examiner may discontinue the repeat examination.
The Examination:  Examinations are handled either through the mail or through a face-to-face interview.  The letter you received indicates that the examination will be conducted through a face-to-face interview.  The examination should take place at a reasonable time and place that is convenient for both you and the IRS. If the time and place suggested by the IRS is not convenient, the examiner will try to work out something more suitable.  However, the IRS makes the final determination of how, when, and where the examination takes place.
Your major decision at this point is to decide who will attend the audit on your behalf. You may represent yourself, you may have someone else accompany you, or, with proper written authorization, you may have someone represent you in your absence.  Please give me a call if you wish to discuss this decision.
You may make a sound recording of the examination.  However, you must notify the examiner in advance so that he or she can do the same.
At the end of the audit, the IRS will give you (or your representative) a written explanation of any proposed changes to your tax return.
Agreed Audits:  If you agree with the results of the audit, you may sign the consent form provided by the IRS. You may pay the tax at this time, or wait until the IRS sends a bill. Interest is charged on the additional tax from the due date of the return.  However, the IRS must send a bill within 30 days from the date the consent agreement is signed.  If it does not, it cannot charge interest after the end of the 30 days until the bill is sent.  Under changes made by the Taxpayer Bill of Rights 2, and assuming the amount of additional tax is less than $100,000 no further interest or penalties are charged if the amount due is paid within 21 calendar days after the billing date.  Even if the amount is over $100,000, you would have 10 business days to pay the amount before additional interest and penalties are charged.
Unagreed Audits:  If you do not agree with the examiner's report, your first option is to meet (personally or through your representative) with the examiner's supervisor to discuss the report further.  If you reach an agreement with the supervisor, the case is closed.  If no agreement is reached, the IRS issues a written preliminary notice of proposed adjustments (30-day letter).  If you still do not agree with the 30-day letter, you have the right to appeal the findings within the IRS or to go to court.  If you are eventually found to be liable for tax, you will be liable for interest on the tax deficiency and possibly penalties.