The IRS’ use of AI changes the tax audit game

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The IRS has been weakened over the past decade or so by budget cuts and staffing shortages. Recent funding from the Inflation Reduction Act of 2022, however, could resurrect its powers, creating a new era of tax enforcement with greater reach using technology as its weapon.

In the past, many of the IRS’ audits targeted low-hanging fruit, which happened to be lower-income taxpayers thanks to their simpler returns — and the tremendous amount of fraud surrounding credits meant for low-income earners. The new era of the IRS is now putting a full-court press on catching missed taxes from high-net-worth individuals and large corporations. These earners typically have complex income streams, intricate business structures, and investments that require more specialized expertise to audit effectively.

In addition, the IRS will specifically target abusive tax schemes such as partnerships that seek to provide write-offs or credits with no economic benefits. It will also target syndicators of these schemes and crack down on tax preparers and promoters who actively encourage and execute abusive tax evasion schemes. The technology and tools employed will help identify these syndications early, allowing the IRS to shut them down quickly and prosecute those involved.

The IRS is hiring and training thousands of auditors to manage this new workload, many with backgrounds in accounting, computer science and finance. These agents will be better equipped to tackle the intricacies of large partnership audits and navigate multi-tiered entities that make audits more challenging.

Relying on new tools

Dan Gordon, CPA

This new focus isn’t simply about deploying waves of auditors; it’s about a fundamental change in the traditional audit approach. Artificial intelligence (AI) and advanced data analytics tools will be at the forefront of identifying high-risk tax returns. These tools include:

• Data matching. AI-powered data-matching algorithms will compare reported income against information provided by employers, banks and investment firms. These systems can quickly spot discrepancies, revealing areas requiring further investigation.
• Predictive analytics. The IRS will use predictive modeling to identify patterns and red flags associated with tax avoidance and evasion schemes. Auditors will be alerted to specific accounts or types of returns warranting additional attention.
• Machine learning. Machine learning systems will learn from past audits and successful enforcement actions. This knowledge base will continuously enhance the IRS’ ability to select returns with a greater chance of a tax issue.

AI will be used for risk identification by analyzing taxpayer data to spot patterns, anomalies and trends that suggest underreporting. This will allow agents to focus audits on areas with higher likelihoods of non-compliance. In addition, AI will assist in processing large volumes of documents and tax forms, extracting relevant information and identifying inconsistencies while developing risk profiles for different types of taxpayers, businesses and industries — and further helping to predict instances of non-compliance.

Avoiding risk

What can we expect from the “new” IRS? Greater scrutiny, for starters. We’ve seen many of our clients invest in questionable partnerships to gain the write-offs in recent years. Make sure if you invest in one or more of these partnerships that they are not in the IRS’ crosshairs.

While this will be the new reality, this transformation of the IRS will take time. But one thing is certain: Intentional tax evasion has become far riskier than in the past. Always choose the path of full compliance; utilize the IRS’ educational resources if needed; and seek a competent tax professional’s help when the intricacies of your return exceed your knowledge.