How the IRS operates: a practical, step-by-step guide

The IRS is the federal agency charged with administering the nation’s tax laws and collecting federal taxes. While the phrase “IRS” often evokes audits and notices, much of its daily work is routine: processing millions of returns, issuing refunds, answering taxpayer questions, and running compliance programs. In my 15 years as a CPA and financial educator I’ve found that knowing the agency’s routine processes makes it much easier to respond quickly if a problem arises.

Below is a clear, actionable breakdown of how the IRS works and what you should do at each stage.

1) Tax reporting and withholding

Most U.S. taxpayers are subject to withholding from wages (Form W-2) or pay estimated taxes if self-employed. Employers and payers report income to the IRS on information returns (e.g., W-2, 1099 series). The IRS uses those third‑party reports to match the income you report on your return.

Action for taxpayers: review your W-2s/1099s for accuracy, adjust payroll withholding when your life changes (marriage, new job, large side income), and keep a simple record of nonpayroll income and expenses. See IRS withholding guidance (irs.gov) for exact steps.

2) Filing and return processing

When you file a tax return (electronically or on paper) the IRS validates your return against third‑party reports, computes tax liability, and posts the results to your account. E‑filing with direct deposit is the fastest way to get refunds; the IRS typically issues most refunds within about 21 days for electronically filed returns when there are no issues, but individual cases vary (IRS, “Where’s My Refund?” 2025) (https://www.irs.gov/refunds).

Action for taxpayers: e-file and choose direct deposit when possible, and use the IRS “Where’s My Refund?” tool to check status.

3) Assessment, adjustments, and refunds

If the IRS accepts your return, they will assess tax and either bill you for a balance due or issue a refund. If there is a mismatch between what you reported and what third parties reported, the IRS may adjust the return and send a notice explaining the change.

Action: read IRS notices carefully—most can be resolved by providing documentation or filing an amended return (Form 1040-X) if you made an error (https://www.irs.gov/forms-pubs/about-form-1040-x).

4) Compliance and enforcement: audits and collections

Enforcement ranges from automated notices to in‑person audits and criminal investigation. Common audit types are correspondence audits (document requests by mail), office audits (in-person meetings at an IRS office), and field audits (an IRS agent visits your place of business or home). The IRS selects returns for review using data matching, anomaly detection, and sometimes random sampling.

Statute of limitations: generally, the IRS has three years from the date you file to audit your return; six years if you substantially understate income (more than 25% of gross income), and there is no time limit for returns filed fraudulently or if no return was filed (IRS, Internal Revenue Manual and publications, 2025).

Action: maintain records for at least three to seven years depending on circumstances, respond to requests promptly, and, if needed, consult a qualified representative.

5) Collections and payment options

If you owe taxes, the IRS will send a bill and may assess penalties and interest. Options to manage unpaid tax include:

  • Installment agreements (monthly payment plans)
  • Offer in Compromise (settle for less than full amount when eligible)
  • Currently Not Collectible status (temporary financial hardship)

You can apply for many payment options online at IRS.gov or by responding to IRS notices (IRS, Payment Plans & Online Payment Agreement, 2025).

Action: don’t ignore bills—contact the IRS or a tax professional to arrange a plan early to minimize penalties and collection actions.

Common triggers and how audits work in practice

What often leads to additional review? Mismatched income reported on forms, large charitable deductions relative to income, excessive business losses, unreported foreign accounts, or claiming credits without proper documentation (e.g., EITC). The IRS’s selection process isn’t public, but common red flags are well-known through experience and IRS guidance.

If you are audited, here’s a practical roadmap:

  1. Read the notice carefully and confirm the authenticity (scammers imitate IRS—real IRS notices come by mail; the IRS will not initiate contact by email requesting personal financial information) (Taxpayer Advocate Service and IRS guidance).
  2. Gather requested documents, organized chronologically.
  3. Respond by the deadline; call the number on the notice for procedural questions.
  4. Consider representation—CPAs, enrolled agents (EAs), or tax attorneys can correspond with the IRS on your behalf.
  5. If you disagree, use the Appeals process before paying disputed tax; the IRS has an independent Office of Appeals (IRS and Taxpayer Advocate Service resources).

For specifics on triggers and preparation, see our in‑depth guides: “What Triggers an IRS Audit: Red Flags and How to Avoid Them” and “How to prepare for an IRS audit” (internal resources linked below).

Real‑world examples from practice

  • Self‑Employed Income: I worked with a client who earned freelance income and held a W‑2 job. He initially underreported 1099 income on a draft return because records were scattered. After consolidating bank statements and invoices, we filed an amended return that properly reflected business deductions and avoided a potential understatement that could trigger deeper review.

  • Notice for Unpaid Tax: A retired client received a Notice CP14 for unpaid tax due to incorrect pension withholding. We reviewed paystubs and negotiated an installment agreement online with the IRS, avoided lien action, and removed stress from the household budget.

These are typical—timely records and quick engagement with the IRS drastically reduce escalation.

Practical taxpayer tips (what I tell clients)

  • Keep good records: save receipts, bank statements, year‑end employer documents, and proof of charitable donations. A digital backup is sufficient if it’s legible and complete.
  • Respond quickly to IRS letters: most problems are resolved by communication and documentation.
  • Use IRS self‑service tools: Where’s My Refund?, Get Transcript, Payment Plan applications (https://www.irs.gov).
  • Get professional help for complex items: business ownership, rental real estate, significant foreign assets, or potential criminal exposure.

Mistakes to avoid

  • Ignoring mail from the IRS.
  • Relying solely on memory instead of documentation for deductions.
  • Missing statute of limitations windows—don’t destroy records needed to support a claim or refund.
  • Paying a tax relief company that guarantees results for a big upfront fee; check credentials and reviews first.

FAQs (short answers)

  • How can I check my refund? Use the IRS “Where’s My Refund?” tool at IRS.gov/refunds (IRS, 2025).
  • What happens if I don’t file? Penalties and interest accrue; criminal exposure is possible in extreme cases. File even if you can’t pay and then work out a payment plan.
  • How long can the IRS audit me? Typically three years after filing; six years for substantial omission; indefinitely for fraud or no return.

Internal articles on FinHelp that expand on key topics:

Final checklist: what to do if the IRS contacts you

  1. Confirm the notice is genuine.
  2. Read the notice and note deadlines.
  3. Gather records and prepare a concise response.
  4. Contact a tax professional if the issue is complex.
  5. Use online tools to pay or request a payment plan if you owe.

Professional disclaimer: This article is educational and general in nature and does not constitute tax advice. Rules change and individual circumstances vary—consult a qualified tax professional for personalized guidance. Sources referenced include IRS.gov and the Taxpayer Advocate Service (all links current as of 2025).