What Is the Internal Revenue Service (IRS)?

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 President Abraham Lincoln, the agency operates under the authority of the United States Department of the Treasury, and its primary purpose includes the collection of individual income taxes and employment taxes. The IRS also handles corporate, gift, excise, and estate taxes, including mutual funds and dividends.

How the Internal Revenue Service Works

Headquartered in Washington, D.C., the IRS services the taxation of all American individuals and companies. For the 2019 fiscal year (Oct. 1, 2018, through Sept. 30, 2019), it processed more than 250 million income tax returns and other forms. During that period the IRS collected more than $3.5 trillion in revenue and issued more than $452 billion in tax refunds.

Individuals and corporations have the option to file income returns electronically, thanks to computer technology, software programs, and secure internet connections. The number of income taxes that use e-file has grown steadily since the IRS began the program, and now the overwhelming majority are filed this way. During fiscal year 2019, nearly 89.1% of all individual returns made use of the e-file option. By comparison, 40 million out of nearly 131 million returns, or nearly 31%, used the e-file option in 2001.

As of Nov. 2019, nearly 92 million taxpayers received their returns through direct deposit rather than a traditional paper check, and the average direct-deposited amount was $2,975.

Although the Internal Revenue Service (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 the 2019 fiscal year, the agency audited 771,095 tax returns. This number breaks down to 0.60% of individual income tax returns and 0.97% of corporate tax returns. Around 73.8% of IRS audits occurred through correspondence, while 26.2% happened in the field. 

After rising to a peak in 2010, the number of audits has steadily dropped each year. The amount of funding set aside for tax enforcement has declined 15% from 2010 to 2018, which indicates even fewer audits should occur.

Reasons for an IRS audit vary, but some factors may increase the odds of an examination. Chief among them: higher income. In 2018, the audit rate for all individual income tax returns was 0.6%, but for someone who made more than $1 million in income, it was 3.2%.

And running your own business carries greater risks too. Individuals making between $200,000 and $1 million in one tax year who don't file Schedule C (the form for the self-employed) have a .6% chance of being audited, vs. 1.4% — basically double — for those who do.

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.