What Is the Internal Revenue Service (IRS)? How Auditing Works

What Is the Internal Revenue Service (IRS)?

The Internal Revenue Service (IRS) is a U.S. government agency responsible for the collection of taxes and enforcement of tax laws (such as the wash sale rule). Established in 1862 by then-President Abraham Lincoln, the agency operates under the authority of the U.S. Department of the Treasury, and its primary purpose is the collection of individual income taxes and employment taxes. The IRS also handles corporate, gift, excise, and estate taxes.

As of November 2021, the head of the IRS is Commissioner Charles P. Rettig, who was nominated to the post by then-President Donald Trump in 2018. He oversees a workforce of about 80,000 and a budget of more than $11 billion. A graduate of New York University, Rettig is the first commissioner since the 1990s to come to the job from a career in tax law rather than business management.

Key Takeaways

  • Founded in 1862, the Internal Revenue Service (IRS) is a U.S. federal agency responsible for the collection of taxes and enforcement of tax laws.
  • Most of the work of the IRS involves income taxes, both corporate and individual; it processed nearly 240 million tax returns in 2020.
  • More than 94% of tax returns were filed electronically in 2020.
  • After peaking in 2010, IRS audits have been on the decline each year.

How Powerful Is The IRS?

How the Internal Revenue Service Works

Headquartered in Washington, D.C., the IRS services the taxation of all American individuals and companies. For fiscal year (FY) 2020 (Oct. 1, 2019, through Sept. 30, 2020), it processed more than 240 million income tax returns and other forms. During that period, the IRS collected more than $3.5 trillion in revenue and issued more than $736 billion in tax refunds (which included $268 billion in economic impact payments due to the COVID-19 pandemic).

Individuals and corporations have the option to file income tax returns electronically, thanks to computer technology, software programs, and secure internet connections. The number of income tax returns that use e-file has grown steadily since the IRS began the program, and the overwhelming majority are now filed this way. During FY 2020, nearly 94.3% of all individual returns made use of the e-file option. By comparison, only about 40 million out of nearly 131 million returns, or nearly 31%, used it in 2001.

As of October 2021, just over 112 million taxpayers received their refunds through direct deposit rather than by a traditional paper check, and the average direct-deposited amount was $2,851.

Although the IRS recommends filing tax returns electronically, it does not endorse any particular platform or filing software.

The IRS and Audits

As part of its enforcement mission, the IRS audits a select portion of income tax returns every year. For FY 2020, the agency audited 509,917 tax returns. This number breaks down to 0.63% of individual income tax returns and 1.0% of corporate tax returns. Around 72.6% of IRS audits occurred through correspondence, while 27.4% happened in the field. 

After rising to a peak in 2010, the number of audits has dropped steadily each year. The amount of funding set aside for tax enforcement has declined by about 30% from 2010 to 2020, which indicates that even fewer audits should occur.

Reasons for an IRS audit vary, but some factors may increase the odds of an examination. Chief among them is higher income. In 2020, the audit rate for all individual income tax returns was 0.63%. However, for someone who made more than $10 million, it was 9.8%.

Running your own business also carries greater risks. Individuals making $200,000 to $1 million in 2018 who didn’t file Schedule C (the form for the self-employed) had a 0.6% chance of being audited, vs. 1.4%—basically double—for those who did.

Other red flags for an audit include failing to declare the right amount of income, claiming a higher-than-normal amount of deductions (especially business-related ones), making disproportionately large charitable donations compared to income, and claiming rental real estate losses. No single factor determines who does or does not face an IRS audit each year.

How to Interface with the IRS

By mail

There are numerous ways to contact the IRS. If you are filing a tax return by mail, your state of residence and whether or not you are expecting a tax refund will determine the address that you should use. There is a list on the IRS website. If you are sending an application or a payment, there is also a list on the IRS website of mailing addresses depending on your purpose.

By phone or online

Individuals who want assistance can phone (800) 829-1040, Monday through Friday, 7 a.m. to 7 p.m. Eastern time (ET), and there are other toll-free numbers for businesses and other purposes. However, it can take some doing to reach an actual person. CPA Amy Northard has helpfully decoded the process on her blog, and it involves a lengthy series of responses you must make to automated questions. Investopedia has vetted it for accuracy. For online assistance for a variety of questions, use the Interactive Tax Assistant on the IRS website.

In person

You can also set up an in-person appointment by phone at your local IRS office. The IRS website has a locator page into which you merely type your ZIP code to get the office location and phone number.

Paying Your Taxes

You can pay your taxes to the IRS through an electronic transfer of funds from your bank account or by using a debit or credit card. Other methods include a same-day bank wire or an electronic funds withdrawal at the time that you e-file your return. If you are a business, or if you are making a large payment, you can use the Electronic Federal Tax Paying System, but you must first enroll in it.

If you are not paying electronically, you have other options. You can mail in a personal check, cashier’s check, or money order. Make it payable to “U.S. Treasury,” and be sure that it contains the following information:

  • Your name and address
  • Daytime phone number
  • Social Security number (the SSN shown first if it’s a joint return) or employer identification number
  • Tax year
  • Related tax form or notice number

You may pay in cash if you wish, you may, but never send cash through the mail. Instead, make an in-person appointment at an IRS Taxpayer Assistance Center by calling (844) 545-5640, Monday through Friday, 7 a.m. to 7 p.m. ET. You should call 30 to 60 days before the day when you want to pay.

You can also pay cash at one of the IRS Retail Partners: 7-Eleven, ACE Cash Express, Casey’s General Stores, CVS Pharmacy, Family Dollar, Dollar General, Walgreens, Pilot Flying J, Speedway, Kum & Go, Stripes, Royal Farms, GoMart, and Kwik Trip. This involves first getting a payment code sent to you by the IRS via email, which you must present when making your payment. There is a limit of $1,000 per payment.

When was the IRS first established?

The IRS was established in 1862 by then-President Abraham Lincoln, who instituted an income tax to pay for the Civil War. The tax was repealed in 1872, revived in 1894, and declared unconstitutional by the U.S. Supreme Court in 1895. In 1913, the 16th Amendment to the U.S. Constitution reinstated the federal income tax.

What is the best way to file my tax return?

It’s best to file your taxes electronically, which 94.3% of taxpayers did in 2020. You can still file a paper return by mail, but doing so will delay your receipt of any refund.

How can I pay my taxes?

The most popular way to pay your taxes is by electronic transfer, either directly from your bank account or through a debit or credit card. However, you can also pay by check or money order, and you can even pay in person—using cash if you wish.

How likely is it that the IRS will audit my taxes?

In 2020, the audit rate for individual tax returns was 0.63%. However, your chances go up if you make big bucks. The 2020 rate for people making $10 million or more was 9.8%. However, no one single factor determines whether or not the IRS will audit you.

Article Sources
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