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Unlocking the Future of Tax Audits: The Role of AI in IRS Enforcement

The tax season is upon us, and the Internal Revenue Service (IRS) is wielding a new weapon in its arsenal: artificial intelligence (AI). AI has revolutionized countless industries, and tax enforcement is no exception. The IRS, empowered by the Inflation Reduction Act of 2022, is leveraging AI to enhance its auditing capabilities, particularly in areas where audit coverage has declined.

This means large partnerships, corporations, and employment tax returns are now under closer scrutiny. The goal? To crack down on tax avoidance, especially among high-net-worth individuals and wealthy corporations.

AI Auditing: A Double-Edged Sword

While AI promises increased efficiency in tax audits, concerns linger about privacy, bias, and transparency. Industry experts like James Creech, a senior manager at Baker Tilly’s tax advocacy team, have voiced their apprehensions in a Thomson Reuters report. He worries that AI might flag perfectly legitimate returns that simply deviate slightly from the norm. Safeguards, Creech emphasizes, are crucial in this new era of AI-driven tax enforcement.

However, Creech also acknowledges the potential of AI, particularly in streamlining partnership audits. AI tools have already facilitated better issue selection, leading to faster audits and more targeted inquiries.

The Road Ahead: Challenges and Opportunities

The IRS’s Strategic Operating Plan for 2023-2031 outlines a clear commitment to bolstering enforcement, particularly for large corporations and partnerships. Yet, the human element remains vital in AI implementation. As Creech points out, algorithms have played a role in audit selection for some time, with the “discriminant function” (DIF) score being used for years. While he believes AI will progressively improve audit selection, he emphasizes the importance of human intervention in interpreting the data generated by AI algorithms.

This human oversight will be critical as AI becomes even more ingrained in the audit process.

AI and the Employee Retention Tax Credit (ERC)

Tax professionals might need to navigate unfamiliar territory as the IRS leans more heavily on AI. This includes a potential surge in ERC audits. The unexpected suspension of ERC applications in September 2023 followed by the December 2023 program allowing voluntary “mistakenly claimed” credit admissions highlight the uncertainty surrounding the ERC.

The limited data available for the ERC poses a particular challenge for AI. Creech underscores the dependence of AI on vast datasets, making programs like the ERC less amenable to AI scrutiny.

Avoiding the Red Flags: How to Stay Compliant

Wealthy taxpayers should be aware of potential audit triggers. According to Kiplinger, these red flags include unsubstantiated claims of Puerto Rican residency, offshore asset transfers, and significant cryptocurrency transactions. The IRS’s AI algorithms are designed to detect patterns indicative of tax evasion, underlining the importance of tax compliance.

The integration of AI into tax enforcement promises improved efficiency and potentially better customer service. However, significant challenges remain, including concerns about algorithmic bias, human interpretation of AI data, and limitations in data availability. Only time will tell the full impact of AI on taxes.

In the meantime, as the IRS navigates the intersection of emerging technology and tax compliance, the onus falls on both taxpayers and tax professionals to prioritize diligence and integrity. Complying with tax laws and regulations remains paramount, especially with the growing role of AI in tax enforcement.

JS Morlu LLC is a top-tier accounting firm based in Woodbridge, Virginia, with a team of highly experienced and qualified CPAs and business advisors. We are dedicated to providing comprehensive accounting, tax, and business advisory services to clients throughout the Washington, D.C. Metro Area and the surrounding regions. With over a decade of experience, we have cultivated a deep understanding of our clients’ needs and aspirations. We recognize that our clients seek more than just value-added accounting services; they seek a trusted partner who can guide them towards achieving their business goals and personal financial well-being.
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