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

What Is the Internal Revenue Service (IRS)?

The Internal Revenue Service (IRS) is a government agency that administers tax laws and collects federal taxes from U.S. individual and corporate taxpayers. The IRS is a division of the U.S. Treasury Department and ensures that the responsibilities of the Treasury Secretary are followed through under the Internal Revenue Code (IRC).1 Established in 1862, the agency also handles gift, excise, and estate taxes.2 The IRS routinely audits to ensure taxpayers comply with tax laws.

KEY TAKEAWAYS

The Internal Revenue Service is a federal agency responsible for collecting federal taxes and enforcing U.S. tax laws.
Most of the work of the IRS involves individual and corporate income taxes.
Taxpayers can file and pay their taxes electronically, by mail, or in person.
The IRS routinely audits taxpayers randomly or if it detects irregularities in their tax returns.
You can contact the IRS by phone, by mail, online, or in person by making an appointment.

How the Internal Revenue Service (IRS) Works

The IRS traces its roots back to 1862 when President Abraham Lincoln created the Commissioner of Internal Revenue to collect taxes to fund the war. In 1913, Congress was given the power to enact income tax laws, paving the way for the Bureau of Internal Revenue. The agency, whose name was changed to the Internal Revenue Service in the 1950s, went through a series of changes and reorganization to what it is today.3

Based in Washington, D.C., the agency’s mission is to enforce tax laws and collect federal taxes from all taxpayers in the United States, including individuals and corporations. This is done by collecting and processing annual tax returns from tax filers. The agency aims to help taxpayers understand federal tax laws, including gifts, excise taxes, and estates. According to the agency:

U.S. taxpayers must comply with tax laws that U.S. Congress passes
Taxpayers must understand and meet their tax obligations
The IRS is designed to help compliant taxpayers and ensure that those who aren’t compliant pay their sharer1

KEY TAKEAWAYS

$4.1 trillion
The amount of tax revenue collected by the IRS each year. This represents about 96% of the country’s gross receipts.4

Processing federal tax returns and collecting revenue from individual and corporate taxpayers is one of the main roles of the IRS. In cases where a taxpayer is owed money, the IRS issues tax refunds. For the week ending Feb. 24, 2023, the IRS reported:

Receiving 45.98 million individual returns
Processing 45.72 million individual returns
Issuing 35.14 million refunds totaling $108.20 billion5

The IRS operates on a budget that Congress approves. This is divided into four different accounts: TaxpayerServices, Enforcement, Operations Support, and Business Systems Modernization.6 The money allotted to each cannot be reallocated to other sections. The agency requested a budget of $14.1 billion for the 2023 fiscal year and requested that the allocation structure be changed so that money can be moved to support costs in other areas.7

KEY TAKEAWAYS

A commissioner heads up the IRS. Douglas O’Donnell was appointed as the acting commissioner on Nov. 12, 2022.4

Tax Filing and Collection

Filing Your Taxes

The majority of individual taxpayers use Form 1040: U.S. Individual Tax Return Definition, Types, and Use to file their taxes, and those who are 65 and older may use Form 1040-SR: Tax Return for Seniors. These forms are used to report income and determine whether any additional taxes are owed or if a refund is due to the taxpayer.

Corporations use Form 1120: U.S. Corporation Income Tax Return to report their income and tax liabilities. There are variations of the form, depending on the type of corporation, including:

Form 1120-C: U.S. Income Tax Return for Cooperative Associations
Form 1120-F: U.S. Income Tax Return of a Foreign Corporation
Form 1120-H: U.S. Income Tax Return for Homeowners Associations
Form 1120-L: U.S. Life Insurance Company Income Tax Return
Form 1120-S: U.S. Tax Return for an S corporation

Individual and corporate taxpayers may also be required to complete and attach additional forms to their main filing, including schedules, addendums, and issuer-provided documents, such as a W-2 and/or 1099s.

Taxpayers may file their returns by mail or electronically with special tax preparation software designed for consumer use. Although the agency still accepts paper returns, it strongly recommends that taxpayers file electronically to avoid delays. Remember that the agency does not endorse any particular platform or filing software.8 The number of e-filed returns continues to grow, and the overwhelming majority are now filed this way. Remember that taxpayers may also use the services of tax professionals, such as tax preparers or accountants.

Paying Your Taxes

Individual taxpayers can pay their taxes directly to IRS through an electronic transfer of funds from their bank accounts or by using a credit or debit card. Other methods include same-day bank wires or electronic funds withdrawals when you e-file your return. Businesses that make large payments must enroll in and use the Electronic Federal Tax Paying System.9

Taxpayers may also mail in a personal check, cashier’s check, or money order payable to U.S. Treasury. The following information must accompany the payment.

Name and address
Daytime phone number
Social Security number (SSN) or employer identification number (EIN)
Tax year
Related tax form or notice number10

Like paper returns, the IRS strongly recommends electronic payments to avoid delays.

Taxpayers may also pay in cash by making 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. Taxpayers should call 30 to 60 days before they intend to make their payments.11

Cash payments are also accepted at the following IRS retail partners: Dollar General, Family Dollar, CVS Pharmacy, Walgreens, Pilot Travel Centers, 7-Eleven, Speedway, Kum & Go, Royal Farms, Go Mart, and Kwik Trip. Taxpayers must wait to receive a payment code from the IRS via email, which is presented when making the payment. Keep in mind that there is a limit of $500 per payment.12

Fast Fact: The fiscal year runs between Oct. 1 and Sept. 30 for the IRS.

Internal Revenue Service (IRS) Audits

The IRS audits a select portion of income tax returns annually as part of its enforcement mission. Audits ensure that taxpayers are accurate information to the IRS according to tax laws. The agency randomly selects taxpayers to audit or singles out those whose returns are related to others that were audited. In other cases, red flags may alert the IRS to conduct an audit.13

The audit process involves an auditor who reviews the return. This individual may either accept the return or request a review. In the latter case, the taxpayer is notified by mail. The audit involves reviewing paperwork and may be conducted by mail or in person at an IRS office or another location, such as the taxpayer’s home, business, or accountant’s office.13

While there is no single factor that determines who gets an IRS audit each year, the following are just some of the red flags that may trigger a review:

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
Claiming rental real estate losses1314

You may also run the risk of being audited if you run your own business or earn a high income.

The IRS reported 738,959 audits as of the end of the 2021 fiscal year. Out of all of these audits, 0.55% were for individual taxpayers. The agency collected $26.8 billion in additional tax revenue due to these reviews. Audits by mail were primarily conducted (78.4%), while the remaining (21.6%) were conducted face-to-face.15

WARNING!

Make sure you keep all your documents in a safe place in case you get audited. The IRS may include your last three years of returns in an audit but may go back further if it notices a significant error. The agency generally doesn’t go back beyond six years.13

How to Connect with the Internal Revenue Service (IRS)

By Mail

If you file 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.16

If you send an application or a payment, there is also a list on the IRS website of mailing addresses depending on your purpose.17

By Phone or Online

Individuals can contact the IRS by phone at (800) 829-1040, Monday through Friday, 7 a.m. to 7 p.m. local time, and there are other toll-free numbers for businesses and other purposes.18 But it may take some doing to reach a live agent. According to a blog from certified personal accountant (CPA) Amy Northard. you’ll have to answer a series of automated questions first. Investopedia vetted her process for accuracy.19

For online assistance with various questions, use the Interactive Tax Assistant on the IRS website.20

In Person

You can also set up an in-person appointment by phone at your local IRS office.21 The IRS website has a locator page into which you merely type your ZIP code to get the office location and phone number.22

When Was the IRS Established?

The IRS was established in 1862 by 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.23

What Is the Best Way to File My Tax Return?

It’s best to file your taxes electronically, which 90% of taxpayers did in the IRS’s 2021 fiscal year.24 You can still file a paper return by mail, but doing so will delay your refund receipt.

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 even in person—using cash if you wish.

What Are the Chances of Being Audited by the IRS?

The audit rate for individual tax returns was 0.55% in 2021. However, your chances go up if you make big bucks. The 2020 rate for people making $10 million or more was 5.8%.25 However, no single factor determines whether or not the IRS will audit you.

The Bottom Line

If you’ve ever filed a tax return, you should have a pretty basic understanding of what the IRS does. This agency is part of the Treasury and is responsible for collecting taxes and enforcing tax laws. With a history that dates back more than 150 years, the face of the IRS has changed. From individuals who went door-to-door to collect taxes to fund the Civil War, it now accepts returns and payments by mail and electronically. But be sure to report your information to the agency accurately and on a timely basis. If you don’t, you may run the risk of being audited. And remember: Keep all your records in a safe place if the IRS comes knocking.