We take the Internal Revenue Service (IRS) for granted today. It’s a major part of our lives (whether we like it or not), and we assume it’s been that way for generations.
Obviously, the IRS hasn’t always existed. In fact, it’s probably newer than you think. Today, we’re explaining the history of the IRS to help you understand where it came from – and why you pay so much money to the IRS every year.
The Early History of the IRS in the US Civil War
The IRS traces its roots back to the United States Civil War. In 1862, President Lincoln asked Congress to create a position called Commissioner of Internal Revenue. At the same time, President Lincoln enacted an income tax to pay for war expenses. This was the first time an income tax had been assessed to the American people.
10 years later, the tax was repealed. The war had been over for several years, and the income tax was no longer needed.
The United States Enacts a New Income Tax in 1894
The Civil War may have been over, but the foundations for taxes in America – and the foundations of the IRS – had already been laid.
In 1894, America was facing enormous deficits. A new income tax was seen as an easy way to fix those deficits. Congress revived income tax later that year. However, the Supreme Court quickly ruled it unconstitutional.
Specifically, the 1894 income tax failed to meet the constitutional requirement that laws be charged proportionally by population. The income tax was repealed – and income tax disappeared for nearly 20 years.
1913 and the 16th Amendment
The 1894 income tax was unconstitutional. The best way to fix that problem, understandably, was to change the constitution. That’s exactly what Woodrow Wilson did by ratifying the 16th Amendment.
The 16th Amendment to the United States Constitution gave Congress the authority to enact an income tax on the American people.
The new amendment carried some important wording. Here’s the most pertinent part of the amendment:
“Congress shall have the power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”
Wyoming gets credit for being the state to officially ratify the amendment. They were the 36th and final state to ratify the 16th Amendment, giving the amendment the three-quarter majority needed to amend the Constitution.
Later in 1913, Congress created a 1% tax on all net personal incomes above $3,000, including a 6% “surtax” on incomes higher than $500,000. These amounts may not seem like much today. However, due to inflation, fewer than 10% of Americans were affected by the tax at the time.
1913 marked an important milestone in the history of the Internal Revenue Service (even though it would not be called the IRS for decades). In 1913, Americans filed a Form 1040 for the first time in history.
To help manage all of these changes, the United States government established the Bureau of Internal Revenue.
The IRS in the Prohibition Era
In 1919, the United States ratified another amendment to the US constitution. The 18th Amendment banned the sale of alcohol across the United States. America officially entered the Prohibition era.
As part of Prohibition, Congress passed the Volstead Act, giving the Commissioner of Internal Revenue the primary responsibility for enforcing Prohibition.
That responsibility was handed over to the Department of Justice 11 years later. However, the fact that the IRS once enforced Prohibition is an important note in the organization’s history.
One of the most unique stories to come out of the IRS during the Prohibition was – as you may have guessed – the time they charged infamous gangster Al Capone with tax evasion. The IRS Intelligence Unit assigned an undercover agent to Capone’s case, which eventually led to him spending 11 years in prison.
In 1933, Prohibition was repealed. In 1934, the IRS assumed responsibility for alcohol taxation. Interestingly, they were also given the responsibility of administering the National Firearms Act. Later, they were given the task of enforcing tobacco taxes.
World Wars and the Internal Revenue Service
By 1917, American spending had increased. America was fighting a costly war. By 1918, the highest income tax bracket was 77%. In the post-war years, that income tax would drop sharply, down to 24% in 1929, before rising again during the Depression to pay for the increased government spending.
In 1942, President Roosevelt was facing rising expenses during the height of World War II. He passed The Revenue Act to help ease deficits during this time period, calling it “the greatest tax bill in American history”. The bill passed through Congress and would change the way Americans viewed taxes to this day.
The major change with FDR’s Revenue Act was that it not only increased taxes, but it also increased the number of Americans who had to pay income tax. The Revenue Act also created deductions for medical and investment expenses.
By the time the Second World War was over, Congress had introduced new tax features like payroll withholding and quarterly tax payments as part of the Current Tax Payment Act (1943) and the Individual Income Tax Act (1944). Just like Form 1040, these systems helped pave the way for the tax system we know today.
1950s and the Birth of the Internal Revenue Service
Up to this point, the organization handling America’s taxes was called the Bureau of Internal Revenue. In the 1950s, the organization was renamed the Internal Revenue Service.
The 1950s marked more than just a name change for the IRS. America’s population was exploding with growth at the time. The economy was booming, and the IRS was recording record tax revenue. The organization needed to be significantly re-organized to handle the demands of an increasingly modern America.
President Truman recognized that changes needed to be made. In 1952, President Truman proposed something he called Reorganization Plan No. 1. This plan replaced the patronage system at the IRS with a career civil service system. It also decentralized service to taxpayers in a move designed to restore public confidence in the agency.
In 1953, new President Eisenhower endorsed Truman’s reorganization plan. That same year, the organization’s name was changed to the Internal Revenue Service.
The other major change to the IRS in the 1950s was that the filing deadline for individual tax returns was changed from March 15 to April 15. This change occurred in 1954.
1960s: The IRS Embraces New Technology
The IRS, like many long-standing organizations, has a history of embracing new technology as it emerges. This attitude was particularly evident in the 1960s.
In 1961, the IRS officially entered the computer age with the launch of the National Computer Center at Martinsburg, West Virginia.
In 1965, the IRS instituted its first toll-free telephone line, allowing taxpayers to call with any questions they had. Just like with Truman in the 1950s, the organization was attempting to increase its transparency and boost public confidence.
Changes in the 1970s
The first major change to the IRS in the 1970s occurred when the Alcohol, Tobacco and Firearms division of the IRS split off to form its own organization, the newly-independent Bureau of Alcohol, Tobacco and Firearms.
Later that decade, in 1974, Congress passed the Employee Retirement and Income Security Act. This act transferred responsibility for overseeing employee benefit plans to the IRS. This move was designed to ensure employers stayed responsible in paying their employees any benefits legally owed.
1980s and Electronic Filing
You probably think of electronic filing as a relatively new phenomenon. However, electronic filing is actually older than the World Wide Web. In 1986, the IRS began to accept limited electronic filing.
By 1992, all taxpayers who owed money to the IRS were eligible to file their taxes electronically. By 2003, more than 40% of individual tax returns were filed electronically (52.9 million returns).
Today, the vast majority of Americans file taxes electronically.
Reagan’s Tax Reform Act of 1986
Taxes had been consistently high for most of the 20th century – especially for America’s highest income tax bracket. Reagan decided to lower taxes with his Tax Reform Act, the most significant piece of tax legislation in 30 years.
The Tax Reform Act contained 300 provisions and took three years to fully implemented. This was just the third time America’s tax laws had been codified since the Revenue Act of 1918.
The Tax Reform Act of 1986 introduced major changes to America’s taxes. The Act came with several major goals:
-The Act was designed to be tax-revenue neutral (Reagan had previously stated he would veto any bill that wasn’t revenue neutral).
-The Act achieved revenue neutrality by decreasing individual income tax rates and eliminating $30 billion in annual loopholes while simultaneously increasing corporate taxes, capital gains taxes, and miscellaneous excises.
-The Tax Reform Act of 1986, overall, drastically reduced the number of deductions and lowered the number of income tax brackets (the new Act led to just three income tax brackets for individuals)
-The top tax rate for individuals was lowered from 50% to 28%, while the bottom rate was raised from 11% to 15%
-Tax incentives were created to encourage Americans to invest in owner-occupied housing relative to rental housing (the most important change was to increase the Home Mortgage Interest Deduction)
-There were over 300 changes in the Tax Reform Act in total. You can read about more of those changes here, as they’re outside the scope of our History of the IRS article
The most important effect of the Tax Reform Act of 1986 was that it raised overall revenue by $54.9 billion in the first fiscal year after it was enacted.
1998 and the Passing of the IRS Restructuring and Reform Act
The next major change to the Internal Revenue Service occurred in 1998 when Congress passed the IRS Restructuring and Reform Act. That Act expanded taxpayer rights, calling for a reorganization of the agency into four operating divisions. Each division was aligned with taxpayers’ needs.
By the year 2000, the IRS had abandoned its geography-based divisions of years gone by. Now, it went with four major operating divisions based on different types of income, including:
-Wage and Investment: This division (based in Atlanta, Georgia) covers the majority of individual taxpayers. More of America’s taxpayers (about 88 million individuals) will deal with this organization than any other. This is the organization that handles your Form 1040s.
-Small Business/Self-Employed: This division is based in the D.C. area. As you probably guessed from the name, it handles all individuals who are self-employed, or any small businesses with $10 million or less in assets.
-Large and Mid-Size Business: This division is based in central New Jersey. Its responsibilities cover all businesses with assets totaling more than $10 million.
-Tax Exempt and Government Entities: This is another D.C.-area office that works with organizations that don’t fall into the categories listed above, including universities, state governments, and smaller non-profit organizations.
These changes were the most significant organizational changes faced by the IRS since the reorganization of 1953.
The IRS Today
You might pay thousands of dollars to the IRS every year – but do you have any idea of how the IRS is organized today? After all the reforms and changes we’ve mentioned above, here are the basic facts you need to know about the organization of the IRS:
-The IRS falls under the Department of the Treasury.
-There are only two appointed positions in the IRS, including the Commissioner of Internal Revenue and the Chief Counsel. The President appoints these individuals and the Senate confirms the candidates.
-The Commissioner of Internal Revenue is the head of the IRS. He serves a renewable five year term. The Chief Counsel, on the other hand, advises the IRS on legal matters. The Chief Counsel will interpret and enforce tax laws as they pertain to the IRS.
-To keep everybody in line, the IRS has a nine member IRS Oversight Board. The goal of this board is to ensure that taxpayers are treated fairly by the agency. The Oversight Board also reviews all IRS plans.
-The IRS continues to be headquartered in DC to this day. However, the organization has many regional offices across the country. The nine regional offices of the IRS (called “campuses”) can be found in Andover, Maryland; Atlanta, Georgia; Austin, Texas; Cincinnati, Ohio; Fresno, California; Kansas City, Kansas; Memphis, Tennessee; Ogden, Utah; and Philadelphia, Pennsylvania.
-The IRS has something called the IRS Appeals Office. The goal of this office is to find an impartial resolution to tax disputes without forcing the IRS and the taxpayer to go to court.
-There’s also the National Taxpayer Advocate Office, which works within the agency and helps taxpayers with all types of IRS problems.
-Finally, there’s the Criminal Investigation (CI) unit of the IRS, designed specifically to investigate any crimes related to violation of the tax code.
Where is the IRS Going in the Future?
Today, the IRS is one of the largest government organizations. It processes trillions of dollars of revenue and hundreds of millions of tax returns every year. It’s an enormous entity built to efficiently process one of the world’s largest populations.
In the 2015 fiscal year alone, the IRS processed approximately 240 million returns, collecting $3.3 trillion in revenue. For every $100 collected by the IRS, the agency spent 35 cents.
Regardless of how you feel about the IRS, it has played a crucial role in American history – and it will continue to play an important role for decades into the future.
