Why Do We Have to File Taxes If the IRS Already Knows?

Many individuals wonder why they must still file tax returns when the Internal Revenue Service (IRS) already possesses much of their financial information. While employers, banks, and other entities report income to the IRS, the tax system operates on a self-assessment model. This requires taxpayers to actively participate in determining their final tax liability, ensuring accuracy and allowing for the application of tax provisions the IRS cannot ascertain independently.

Information Automatically Reported to the IRS

Third parties, such as employers and financial institutions, send various forms directly to the IRS, providing a foundational layer of a taxpayer’s financial activity. These include:
Form W-2, Wage and Tax Statement, detailing wages and taxes withheld.
Form 1099-INT for interest income.
Form 1099-DIV for dividends.
Form 1099-B for proceeds from stock and security transactions.
Form 1099-R for retirement plan distributions.
Form 1099-NEC for nonemployee compensation, such as payments to independent contractors.

The IRS uses this third-party information to verify income declared on tax returns. While this system provides significant data, it only represents a partial picture of an individual’s complete financial situation. For instance, the threshold for Form 1099-K reporting from third-party payment networks like PayPal or Venmo is $5,000 in 2024, reducing to $2,500 in 2025, capturing more business transactions.

Information Only You Can Provide

Despite the extensive information the IRS receives from third parties, much data impacting your final tax liability remains known only to you. This includes details like deductions and credits, which reduce the amount of tax owed or increase a refund. For example, above-the-line deductions, such as contributions to traditional Individual Retirement Arrangements (IRAs), student loan interest, or Health Savings Account (HSA) contributions, are subtracted from your gross income to arrive at your adjusted gross income (AGI). These deductions are available even if you do not itemize.

Itemized deductions, claimed on Schedule A of Form 1040, include expenses like mortgage interest, state and local taxes (up to a limit), medical expenses exceeding a certain percentage of AGI, and charitable contributions. The IRS does not automatically have details about these personal expenses. Tax credits, such as the Child Tax Credit, Earned Income Tax Credit (EITC), or education credits, directly reduce your tax liability dollar-for-dollar. Some credits, like the EITC, are refundable, meaning you could receive money back even if you owe no tax.

Additionally, certain income types may not be subject to third-party reporting, such as cash income from a side business, foreign income, or income from hobbies. Taxpayers are responsible for reporting these earnings accurately. For investments, determining the correct cost basis is important for calculating capital gains or losses. While brokers generally report sales proceeds on Form 1099-B, they may not always have complete cost basis information. Without your input on these details, the IRS cannot accurately assess your tax obligations or your eligibility for various tax benefits.

Your Responsibility in Tax Compliance

The United States operates under a self-assessment tax system. Taxpayers are responsible for calculating their tax liability, reporting all income, and claiming eligible deductions and credits. This system relies on individuals to provide complete and accurate information beyond what third parties report. Filing a tax return allows you to reconcile the income reported by others with your full financial picture, ensuring any discrepancies are addressed and your tax obligation is correctly determined.

Filing also allows the IRS to verify the accuracy of both third-party reports and the information you provide. This is important for claiming any overpayments made through withholding or estimated tax payments, leading to a refund. Without filing, you would not receive these refunds or benefit from refundable tax credits you might be due. Preparing a tax return also encourages taxpayers to maintain detailed records of their income, expenses, and other financial transactions. The IRS recommends keeping tax records for at least three years.

The taxes collected through this filing process fund government services and programs that benefit all citizens. These include national defense, healthcare initiatives like Medicare and Medicaid, Social Security, infrastructure projects, and public education. Your participation in filing ensures the integrity of the tax system and contributes to the funding of these collective benefits.