Many Americans and foreigners working or living in the United States only engage with the IRS once a year when they file a federal income tax return and either wait for a refund or transfer money to pay taxes. However, the IRS does a lot more than just collect money and send out refunds.
So, whether you’re familiar or unfamiliar with this government agency, understanding thoroughly about the IRS will definitely help you in your future career. This article will walk you through the IRS, from its name, history, how it works, and the IRS’s importance in our lives.
What does IRS stand for?
Most of you probably have heard about the IRS several times before, but what does IRS stand for actually? IRS stands for the Internal Revenue Service.
Although the Internal Revenue Service didn’t get its name until the 1950s, the origins of the agency date back to the Civil War. President Abraham Lincoln created the IRS through the Revenue Act of 1862 and enacted an income tax to help pay for the Union cost of the Civil War, which lasted for ten years before being repealed.
In 1894, the Wilson Tariff Act reestablished the income tax, but later, in 1895, the Supreme Court ruled the income tax unconstitutional. This meant no income taxes could be collected until three-quarters of the states ratified the 16th Amendment to allow Congress to enact an income tax. This created and established the legality of the first federal income tax program. The first income tax rate was 1% on income over $3,000 and 6% on income over $500,000.
Tax rates increased to finance World War I, then decreased in the postwar years before rising again during the Great Depression and World War II. Tax withholding was instituted at this time.
The tax collection agency was reorganized in the 1950s, and the Bureau of Internal Revenue became the Internal Revenue Service. The IRS was reorganized again in 1998 to become more consumer-focused.
What does the IRS do?
The Internal Revenue Service’s mission, according to its website, is to help America’s taxpayers understand and meet their tax responsibilities and enforce the law with integrity and fairness, and provide top-quality services to achieve these goals. The IRS divides this mission into three distinct responsibilities:
- Administer tax laws:
One of the first and foremost responsibilities of the IRS is to assess and collect taxes on behalf of the federal government. In 2020, the IRS collected nearly $3.5 trillion in taxes, accounting for income taxes, employment taxes, business income taxes, excise taxes, estate, and gift taxes.
Besides collecting taxes, the IRS is also in charge of issuing tax refunds, which an individual or business can claim if they overpay their taxes. In the fiscal year 2020, the IRS processed more than 240.2 million federal tax returns and supplemental documents.
- Enforce tax laws:
An essential part of the IRS’s enforcement mission is to seek and identify those who have underpaid their taxes, whether due to a math error or criminal activity. These examinations can either take the form of correspondence or field examinations. For the 2019 fiscal year, the IRS audited 771,095 tax returns, accounting for 0.6% of individual income tax returns and 0.97% of corporate tax returns. About 73.8% of IRS audits occurred by mail, while 26.2% happened in the field.
From 2010 to 2018, the IRS examined about 0.63% of individual tax returns and 1% of corporate tax returns for errors. While most errors are likely unintentional, the IRS completed 2,624 criminal investigations in 2020 alone.
There are various reasons that the IRS will undertake an audit, but certain factors may increase the odds of an examination. The chief among these factors is high income. The audit rate for all individual income tax returns in 2018 was 0.6%, but for those who earned more than $1 million in income, it was 3.2%.
Running your own business might bring greater risks, too. Individuals who earn between $200,000 to $1 million in one tax year and file a Schedule C (the form for the self-employed) will have a 0.6% chance of being audited. And for those who do not, the chance ranges from 1.4% to 2.8%.
Some noticeable red flags which could trigger an audit are failing to declare the correct amount of income, claiming a larger number of deductions than usual (especially business-related ones), making abnormally large charitable donations compared to income, and claiming rental real estate losses. No single element determines whether or not you will face an IRS audit each year.
- Providing services to assist taxpayers:
Another important responsibility of the IRS is to provide services to taxpayers to help them understand and comply with their obligations. There are numerous reasons for an individual, business, or an exempt organization to call the IRS, but the main reason is the need for help with excise taxes, estate taxes, and gift taxes. You can find these services through the IRS website, its telephone helplines, IRS Taxpayer Assistance Centers, and volunteer tax assistance.
Why is the IRS important?
Income tax revenue, along with other tax revenue, pays for a major part of the activities of the United States Government. Taxes are used to fund Social Security, Medicare, Medicaid, national defense, aid for veterans, foreign affairs, etc. Taxes contribute to community development, pay for law enforcement, and support many government services.
The mission of the IRS is to procure these funds from taxpayers through a variety of passive and more proactive means. The IRS’s secondary purpose is to educate taxpayers on the nature of taxes and their obligations. Therefore, the importance of the IRS can’t be understated.
The bottom line
A successful business starts with great knowledge and experience. Now you know what does IRS stand for, its mission and responsibilities, and how it helps keep the government functioning. You can then prepare how to work with the IRS, from filing taxes to preparing for a business audit.
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