What is the Internal Revenue Service (IRS)?

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Definition:

The Internal Revenue Service (IRS) is a government agency that is responsible for enforcing tax rules and collecting taxes from American businesses and residents.

🤔 Understanding the Internal Revenue Service (IRS)

The United States levies a wide variety of taxes on its residents and businesses. The tax code is complicated, and it takes a lot of effort to make sure that everyone pays the taxes they owe. To help enforce tax laws and ease the collection of taxes, President Abraham Lincoln formed the Internal Revenue Service (IRS). The IRS receives individual tax returns from Americans and selects returns to audit for accuracy, working to correct mistakes that people make or catch people trying to avoid paying their tax bill.

Example

American taxpayers file their tax returns annually. When you file your return, the IRS receives it and decides whether to select it for audit. If it audits your return, it will reach out to you to ask for documentation for the things you claimed on the return. If it doesn’t select you for an audit, the IRS makes a note of your filing and receives any payment that you made along with the filing. If you overpaid your taxes, the IRS processes your refund.

Takeaway

The IRS is kind of like an office’s internal filing system...

When you file your taxes, the IRS takes your tax return and files it into the correct recordkeeping areas. Occasionally, the IRS checks some of the tax returns for accuracy to make sure that the filing system doesn’t become inaccurate.

If any of the filings need an action taken (like a refund of overpaid taxes), the IRS manages the transaction just like someone filing paperwork would for a purchase order.

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What is the Internal Revenue Service (IRS)?

The Internal Revenue Service is a United States government organization that’s part of the Department of the Treasury. The IRS works to administer the United States tax code by collecting taxes from Americans and processing tax returns each year. In 2015, the IRS collected more than $3.5 trillion and processed more than 220 million tax returns.

The IRS operates with two goals. One is educating and assisting taxpayers with paying their legally owed tax. The other is enforcing the law to ensure that people trying to avoid their tax bills are made to pay what they owe.

According to the IRS website, the following describes how the IRS interacts with the government, the public, and the law:

  1. In the United States, Congress passes tax laws and requires taxpayers to comply.
  2. The taxpayer’s role is to understand and meet his or her tax obligations.
  3. The IRS’s role is to help the large majority of compliant taxpayers with the tax law while ensuring that the minority who are unwilling to pay contribute their fair share.

Is the IRS a government agency or a private company?

The IRS is a government agency, not a private company. Congress established the Office of the Commissioner of Internal Revenue under the Department of the Treasury in 1862, formally creating the IRS.

Two years later, the Revenue Act empowered the IRS to collect taxes, “compromise all suits relating to internal revenue,” and provide refunds to taxpayers.

Over the next decades, the government passed additional laws surrounding the IRS and how it could act. This included acts making taxpayer information private and authorizing an income tax.

What is the role of the IRS? Why is it important?

The role of the IRS is to administer the United States tax code, but this encompasses many different activities, all of which are important.

One role, and perhaps the best-known, is tax enforcement. Some taxpayers intentionally misreport their financial information to try to pay less tax than they owe. Others make unintentional mistakes in their reports that cause them to pay more or less than they owe.

As the enforcer of the country’s tax code, the IRS works to make sure that the information that taxpayers report is accurate and that everyone pays what they owe. To enforce the code, the IRS audits returns and investigates individual taxpayers to find discrepancies. The IRS also conducts criminal investigations and charges tax dodgers, bringing them to court as needed.

Another role is assisting taxpayers with paying their tax bills. This includes offering tax filing services and assistance and producing educational materials that help people learn more about the tax code.

Finally, the IRS handles all of the tax returns that Americans submit, dealing with the ensuing paperwork, receiving payments from taxpayers, and disbursing refunds as necessary.

What is an audit?

An audit is a review of a taxpayer’s tax return and financial situation. If the IRS selects you for an audit, the IRS will check your tax return to make sure that you have properly reported all of your income and paid the appropriate taxes.

The IRS selects taxpayers for audit using multiple methods.

One is random chance. Each year, the IRS randomly chooses many tax returns and audits them. The IRS also looks for tax returns that fall outside of norms that it sees in other comparable tax returns. It uses statistical samples of similar taxpayers’ returns and audits some of the returns that fall outside those parameters.

The IRS may also audit your tax return if it finds that you’re related to other taxpayers under audit. For example, if you’ve had close business dealings with someone else who is being audited, there’s a good chance the IRS will review your records as well.

If the IRS decides to audit you, you’ll be informed by mail. The IRS does not call, e-mail, or use any other method of contact to let you know about an audit.

There are two ways that audits can happen: in-person interviews and by mail.

For an in-person audit, you’ll visit an IRS office, or the IRS will send an auditor to your home or place of business. For audits by mail, the IRS will send all communication to your address.

Regardless of how the IRS conducts the audit, you’ll need to provide a variety of information and paperwork. The IRS agent conducting the audit will tell you exactly what you need to provide, but you may need to provide any or all of the following:

  • Receipts
  • Bills
  • Canceled checks
  • Legal papers
  • Loan agreements
  • Medical records
  • Insurance reports documenting losses
  • Employment documents

Usually, you should mail these documents upon request, though the IRS accepts some documents electronically. Law requires that you keep these records for at least three years after filing your taxes so that you have them on hand to deal with an audit. The IRS typically won’t audit returns more than three years old, but it may go back as far as six years if it recognizes a significant error in a more recent tax return.

Audits can end in one of three ways. 1.No change: The audit confirms that your tax return is correct and that you paid all relevant taxes. 2. Agreed: The IRS proposes changes to your tax return based on the findings of the audit, and you agree to those changes. You pay any additional taxes due or accept money refunded. 3. Disagreed: The IRS proposes changes to your tax return, and you disagree with those changes. If so, you must file an appeal or accept mediation.

What causes you to get audited by the IRS?

The IRS selects taxpayers for audit in three ways: randomly, based on differentiation from norms developed using other tax returns, and based on association with other taxpayers selected for audit.

There’s not much you can do to avoid an audit based on random chance or your association with other audited taxpayers. But you can work to make sure that your tax return remains within the norms of similar taxpayers.

One of the most important steps to avoid an audit is making sure that your tax return is accurate. If you enter an incorrect number, for example, inflating a tax deduction, it can trigger a red flag with the IRS that leads to an audit.

Avoid this by double-checking your return before you submit it. Relatedly, make sure that you always tell the truth on your tax return. Lying on your taxes is illegal, and it can make you a more likely target for an audit.

Another way to avoid an audit (although it’s harder to control), is to make sure your income for the year is near the average. High-earning taxpayers are frequently audited because of their complex tax situations.

Many of these taxpayers take multiple different deductions and have many sources of income, leading the IRS to examine them more closely. Similarly, low-income taxpayers that qualify for the Earned Income Tax Credit tend to have more complicated situations that can also result in audits.

Having an average income and using the standard deduction can reduce your audit risk. If you do opt to itemize your deductions, make sure they’re realistic and reasonable. This is especially important for small business owners who can take many deductions that normal taxpayers cannot.

Finally, filing taxes electronically can help you avoid audit because tax preparation programs help reduce the number of errors in tax returns. The IRS reports that 21% of paper returns have some error while only 0.5% of electronic returns have mistakes.

Can the IRS put me in jail?

The IRS handles late payment or non-payment of taxes in multiple ways. Ultimately, the IRS can put you in jail if you don’t pay your taxes, but it is exceedingly rare for this to happen.

The most common penalties for not filing and paying your taxes are penalty fees and interest charges. If you don’t file your tax return by the due date, the IRS typically charges a 5% penalty and an interest rate between 4% and 6%.

If things go on for too long, the IRS might place a lien on your income, whether that income comes from an employer or Social Security. Failure to pay taxes can also give the IRS grounds to repossess your property.

In the worst case, if the IRS determines that your non-payment is willful, meaning that you knowingly and intentionally refused to file and pay your federal taxes accurately, it could charge you with attempting to defraud the government. If a jury finds you guilty, this could lead to jail time.

Before the IRS can take these actions, you’ll receive a notice in the mail. Often, the best thing to do in response to one of these notices is to reach out to the IRS. The IRS is willing to work with taxpayers to help them pay what they owe. Ignoring the problem typically makes the problem worse.

If the IRS owes you a refund, failing to file your taxes might mean that you forfeit your refund.

What does the IRS do with your money?

When you pay taxes, the IRS gives the money to the federal government so the government can spend it on different projects. Your money helps to fund things like NASA, the military, interstate highways, and the national park system.

Some of the things that taxpayer money goes toward include:

  • Social programs like Medicare, Medicaid, and the Supplemental Nutrition Assistance Program
  • Infrastructure and community development
  • Paying down governmental debt
  • National defense
  • Law enforcement
  • Research and development

If you can think of something that the federal government spends money on, some of the money that you pay to the IRS as part of filing your tax return contributes to that spending.

Taxes help to keep the country running and help the government provide vital services to Americans. Paying taxes can be painful because it takes money out of your pocket but this responsibility plays a vital role in making sure the government can help all of its citizens.

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This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Options trading entails significant risk and is not appropriate for all customers. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.

Commission-free trading of stocks, ETFs and options refers to $0 commissions for Robinhood Financial self-directed individual cash or margin brokerage accounts that trade U.S. listed securities and certain OTC securities electronically. Keep in mind, other fees such as trading (non-commission) fees, Gold subscription fees, wire transfer fees, and paper statement fees may apply to your brokerage account. Check out Robinhood Financial’s Fee Schedule for details.

Brokerage services are offered through Robinhood Financial LLC, (RHF) a registered broker dealer (member SIPC) and clearing services through Robinhood Securities, LLC, (RHS) a registered broker dealer (member SIPC). Cryptocurrency services are offered through Robinhood Crypto, LLC (RHC) (NMLS ID: 1702840). Robinhood Crypto is licensed to engage in virtual currency business activity by the New York State Department of Financial Services. The Robinhood spending account is offered through Robinhood Money, LLC (RHY) (NMLS ID: 1990968), a licensed money transmitter. A list of our licenses has more information. The Robinhood Cash Card is a prepaid card issued by Sutton Bank, Member FDIC, pursuant to a license from Mastercard®. Mastercard and the circles design are registered trademarks of Mastercard International Incorporated. RHF, RHY, RHC and RHS are affiliated entities and wholly owned subsidiaries of Robinhood Markets, Inc. RHF, RHY, RHC and RHS are not banks. Products offered by RHF are not FDIC insured and involve risk, including possible loss of principal. RHC is not a member of FINRA and accounts are not FDIC insured or protected by SIPC. RHY is not a member of FINRA, and products are not subject to SIPC protection, but funds held in the Robinhood spending account and Robinhood Cash Card account may be eligible for FDIC pass-through insurance (review the Robinhood Cash Card Agreement and the Robinhood Spending Account Agreement).

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