Money Basics: How the IRS works

Welcome to Money Basics, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important terms involving your money.

The IRS, or Internal Revenue Service, is responsible for collecting taxes and enforcing tax laws within the United States. The IRS collects a staggering amount of money each year, nearly $3.3 trillion for fiscal year 2015. In addition to handling individual income taxes, the bureau also collects employment, estate and excise taxes, among others.

The first income tax was a 3% flat tax on all incomes above $800.

In 1861, Abraham Lincoln signed the Revenue Act and established the first national income tax to fund the Union effort in the Civil War. The subsequent Revenue Act of 1862 expanded upon the income tax by establishing the predecessor to the IRS, the Commissioner of Internal Revenue. By 1872, with the war over and public sentiment turning against taxes, Congress repealed the national income tax. The tax was restored with the ratification of the 16th Amendment to the US Constitution in 1913 and remains in effect today. In 1953, the Bureau of Internal Revenue changed its name to the Internal Revenue Service.

The IRS will sometimes perform audits on a portion of individuals and businesses to ensure that people what they owe in taxes. An audit is an official inspection and review of an organization or individual’s financial dealings to verify tax filings and payments are accurate. Some people are selected at random for an audit while others are audited due to inconsistencies in their tax filings. Glaring math errors, unusually high charitable donations or claiming many business expenses are just a few of the potential red flags on a tax return that could lead to an audit. Speak with your tax preparer and check with the IRS website for more information on why you might be audited.

More from Money Basics:

What is a hedge fund?
What is the Fed?
What is an annuity?
What is a robo-advisor?
What is an ETF?

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