There are different types of IRS audits. The first and least complex is the correspondence audit, next is the office audit, and lastly and most complex, the field examination. I highly recommend to anyone who receives a letter from the IRS, or even the State of NJ, to contact their tax advisor as soon as possible.
The correspondence audit is the most commonly used audit of all three types of audits. It starts with a letter issued from the IRS stating that a change has been made to your tax return, such as for investment income that you failed to report. Assuming in this case the IRS is correct, you will need to submit the additional tax assessed on the unreported income, along with interest to the IRS. If the IRS is not correct and you disagree then you will need to provide an explanation to prove that you do not owe additional taxes. Sometimes the notice is partly right, and the best course of action may be to file an amended return or complete the appropriate forms.
Since correspondence audits are very cost effective for the IRS, they also send letters for specific deductions, such as charitable contributions, to request substantiation for your deductions. This is why it is extremely important to keep all receipts for your deductions, because without any proof that you made donations, your deduction will be disallowed and additional taxes and interest will be assessed.
The next audit, the office examination, takes place at one of the field offices of the IRS by a local agent. Although more complex than a correspondence audit, the agent usually focuses on a select number of items. It is very important to be very prepared for this type of audit because it can lead to the agent broadening the scope of the audit.
Lastly, and most in-depth, is the field examination. This involves an IRS agent visiting your place of business or possibly your home. The agent requests much more information and asks a lot more questions. Again, it is very important to be well-prepared for this audit. It is also crucial to communicate with and work closely with your tax advisor.
After completion of an audit, there can be several outcomes. The first is an assessment of additional taxes, interest, and/or penalties, the second is no change to your tax liability, and third you may actually be due a refund (not likely, but that would be a great outcome)!