Internal Revenue Service, IRS

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IRS stands for Internal Revenue Service and is often known as the agency that collects taxes. But what else do they do? How did they start and what is their role in the taxes you pay.

Check out this in-depth guide on the Internal Revenue Service and how they work. 

History

The IRS dates back to the Civil War when President Lincoln created taxes to help cover the war expenses. Ten years later, the taxes were repealed only to return in 1894.

The back and forth continued through 1918, when taxes were at their highest during World War I and what they called the Bureau of Internal Revenue became the Internal Revenue Service. 

What is the IRS?

The mission of the IRS is to help Americans understand their tax liabilities and how to meet them while ensuring integrity for all.

The IRS doesn’t create the tax laws, Congress does. The IRS they help Americans understand the tax law, how to manage it, as well as enforce those that aren’t paying to do so. 

How the IRS Works

We all know the IRS come April 15th (most years), right? That’s the day your taxes are due or you pay hefty penalties. But do they really do?

As we said above, the IRS enforces the tax laws that Congress puts into place. In order to do that, the IRS:

  • Processes tax returns
  • Offers taxpayer service
  • Enforces the tax laws when taxpayers don’t pay

The IRS is also in charge of managing tax-exempt organizations and tax-exempt retirement plans. A large part of what the IRS does involves enforcement, which includes examining taxpayer returns, going after collections, and dealing with issues with individuals and organizations not following the laws. 

As one of the country’s largest federal agencies, the IRS employs almost 80,000 people. There are just two appointed positions within the IRS – the Commissioner of Internal Revenue and the Chief Counsel. These positions are chosen by the president and the Senate. The Commissioner is the ‘boss of the IRS,’ and the Chief handles the legal matters. 

The IRS has an Oversight Board that keeps a watch over the IRS. They ensure that all agents are treating taxpayers fairly. They also look over the IRS plans, but the positions haven’t been completely filled for 5 years, and the overseeing has taken a back seat. 

The IRS works in four principal areas:

  • Wage and Investment – This is the department most Americans are familiar with as it’s the department that processes tax returns (IRS Form 1040).
  • Small Business/Self-Employed – Businesses with less than $10 million in assets fall under this category and deal with a separate division of the IRS.
  • Large Business and International – This division deals with businesses that have more than $10 million in assets.
  • Tax-Exempt Organizations – This division deals with non-profits and other tax-exempt organizations that meet the IRS guidelines. 
  • Office of Appeals – Since taxes are a hot topic and many don’t agree with what the IRS states, they have an office that deals directly with the disputes, trying to come up with an impartial resolution.
  • Criminal Investigation Unit – This department handles any tax code violations, including fraudulent tax returns and even illegal income.

How Taxes are Paid

Paying taxes is mandatory, but the IRS relies on voluntary compliance. If you work for someone, though, your taxes are automatically withheld, taking the burden off you to make your payments. However, the IRS threatens audits for those that don’t follow the tax code and/or don’t pay their taxes, so there’s that way to enforce the regulations too.

When you start with a new employer, you complete IRS Form W-4. This form determines how much of your paycheck the employer will use to pay your taxes. The amount they withhold depends on your marital status and the number of dependents you claim. The more dependents you claim, the fewer taxes are withheld from your check. If your tax liability is higher than what’s collected at the end of the year, though, you’ll have to pay the difference. 

If you don’t work for an employer that handles your tax payments for you, it’s your responsibility to get the payments in to the IRS. Self-employed, for example, you must send your tax payments in every quarter. Since you don’t know your full tax liability for the year since the year isn’t over yet, you send in estimated payments to the IRS on the 15th of every April, June, September, and January. 

When you file your tax returns, you’ll determine if you overpaid or underpaid. Just like if you worked for someone, if you overpaid, you’ll receive a tax refund and if you underpaid, you must pay the difference by April 15.

Filing Your Taxes

On April 15th each year (except 2020), you must file your tax returns. This is how the IRS determines your full tax liability based on your income for the year. Your income includes more than just the money you make from an employer or your business, it also includes:

  • Investment income
  • Interest income 
  • Alimony
  • Gambling winnings
  • Bartering income
  • 1099 income
  • Forgiven debt

When you file your taxes, you report not only your income but also your deductions. Some common deductions including mortgage interest, real estate taxes, charitable contributions, and personal exemptions based on the number of dependents. If your itemized deductions aren’t more than $12,200 as a single filer or $24,200 as a married couple, you can just take the standard deduction and you don’t have to worry about itemizing your deductions. 

The most important thing is to file your taxes with the IRS by April 15. If you can’t pay the amount you owe, you can work out a payment arrangement with the IRS. They offer several options including giving you more time to come up with the full payment or breaking up the full amount you owe into monthly payments over a period of up to 5 years. 

What are Audits?

If the IRS feels that you didn’t follow the procedure or you were dishonest on your taxes, they may request an audit. An IRS specialist will go over your tax returns over the past predetermined number of years to determine if you paid what you owe and if you reported your income correctly.

If you’re presented with an audit, it doesn’t automatically mean you did something wrong – it just means the IRS wants to look into the situation a little more. But, with the threat of an audit on your back, it’s important to always be honest on your tax returns.

Certain people are more likely to get audited than others. The IRS system does pick taxpayers randomly, but they target people in the following categories:

  • Taxpayers that make mathematical mistakes on their tax returns
  • Failing to report all of your income 
  • Reporting an excessive amount of charitable donations
  • Reporting an excessive amount of business losses
  • Going overboard on business expense write-offs
  • Taxpayers that earn tips
  • Taxpayers that take the home office deduction

Fortunately, the odds of being audited are low, typically less than 1 percent. If there is an audit, sometimes it’s just a request for more documentation and it’s not a full blow in-person audit from the IRS.

The IRS and Expatriates

While an audit feels threatening, expatriates experience even more stress, as they still must file taxes even though they live outside the country.

Even though most expats don’t owe anything, they must go through the hassle of filing their tax returns and completing the necessary disclosures. The cost to complete the tax returns and file them is much higher than for US citizens and causes quite a nuisance for expats. 

Because the numbers look different and accounting methods differ in other countries, it creates a logistical nightmare that often results in high penalties for expats. The IRS requires expats to report all foreign assets, and foreign income, almost as if they were a criminal. 

Tips For Expats And Non-Residents

Expats living or working in the United States receiving foreign income must declare their offshore earnings to the Internal Revenue Service (IRS).

Although the rules are straightforward and similar for US expats living overseas, the IRS has published seven tips to help filing a tax return run smoothly:

Declare worldwide income

Tax laws in the United States require all citizens and resident expats to report their worldwide income to the IRS – including interest and chargeable gains on savings and investments in other countries whether they are held personally or controlled through a trust or company

File the right forms

Make sure the right tax return forms are filed – the IRS suggests checking for filing the following forms which are often overlooked:

  • Schedule B Interest and Ordinary Dividends
  • Form 8938 Statement of Specified Foreign Financial Assets
  • FinCEN Form 114
  • Report of Foreign Bank and Financial Accounts

Don’t miss deadlines

Taxpayers living overseas who believe they might miss the April 15 filing deadline should consider applying for an automatic extension. The extension gives up to an extra two months for filing returns – but you will need to attach a note explaining why you cannot meet the deadline

Check overseas income

Check the Foreign Earned Income Exclusion.  US residents living or working overseas are often eligible for foreign earned income exclusion which means not paying tax on the first $97,600 of any salary and other foreign earned income in 2013.

Watch how much you pay

Taxpayers should always check if they qualify for tax credits or deductions to reduce the amount of tax they have to pay.  Despite a fearsome reputation, the IRS wants people to pay the right amount of tax, not too much or too little.

Go online with the IRS

Take advantage of the online IRS Free File portal. Different software is available depending on whether a taxpayer earns up to $58,000 or more. Some software also works for US expats with overseas addresses.

Get help

Ask for help with filing tax returns – not only does the IRS have comprehensive online help and call centres, but also has offices in London, Frankfurt, Paris and Beijing, where tax advice and help filling in forms is available.

Find out more information

Find out more about help for expat and non-resident taxpayers –

FATCA

The US Foreign Account Tax Compliance Act (FATCA) is in full throttle as tax authorities around the world have started swapping financial data.

FATCA requires foreign financial institutions must tell the IRS about any accounts or investments controlled by US taxpayers.

In return for the data passing through tax authorities and onwards to the IRS, the US is sending back reciprocal information about taxpayers of other nations who have bank accounts or investments in the USA.

Lawsuits and protests

Taxpayers have complained the law breaches their privacy, while financial institutions have spent billions on implementing software systems to identify US taxpayers.

In some cases, banks have closed the accounts of US taxpayers to avoid complying with the law and US taxpayers have handed back their passports.

FATCA was introduced in 2010, but did not start to come into force until July 2015 due to a rough ride through Congress and a series of failed legal challenges both in the US and outside.

The aim of the legislation is to help the IRS find undeclared income and assets of US taxpayers that is hidden offshore.

The government expects to raise around $10 billion of tax from FATCA.

Tax penalties

Foreign financial institutions that fail to pass the data to their national tax authority can register direct with the IRS.

Those that fail to supply the required information face severe penalties from the US government.

These penalties include a 30% withholding tax on any financial transaction the institution makes in the US or even barring from the US banking system.

The Bottom Line

The IRS helps keep Americans following the tax regulations. Every American that has any type of income owes taxes of some sort, but may end up with a $0 liability after the deductions and write-offs. It’s important that you file your taxes and get counsel for any questions you have.

Don’t avoid filing your taxes and always be honest about your income, assets, and any other figures that play a role in your tax filing. While the risk of an audit is low – the IRS can tell when there’s something that isn’t right, which can trigger an audit down the road, even many years down the road.