Did you know that the IRS has recently adopted artificial intelligence (AI) for improved tax compliance? As of February 2024, there are 68 planned and ongoing projects involving this technology. This was funded by the Inflation Reduction Act, to better address some of the more complex tax evasion strategies encountered by the taxman. And currently, the key focus is on high-income earners and large partnerships.
Basically, the IRS wants to address the fall in audit rates among wealthy individuals and complex businesses. At the same time, they want to ensure that tax laws are being enforced equitably, for all taxpayers. But what does this mean for you and your business?
This blog will cover everything you need to know about the IRS’s use of AI and how to ensure that this move doesn’t negatively impact your tax filings.
Why The IRS Started Using AI
The IRS has a few key areas of interest as far as AI use is concerned. This first is to prioritize individuals earning over $1 million who have substantial tax liabilities of over $250,000. This will be done through enhanced audits and enforcement.
The second major initiative involves large partnerships. In the past, less than 1% of partnership returns were audited. That means the taxman has missed out on identifying potential compliance risks and collecting billions of dollars. As a result, partnerships with balance sheet discrepancies are now being flagged for reviews and audits.
The use of this technology also extends to taxpayers with international accounts, or with cryptocurrency, through expanded compliance measures, new reporting regulations, and increased scrutiny. The purpose of AI adoption is to address large-scale tax evasion and improve audit efficiency.
In other words, if your taxes are up-to-date, accurate, and compliant, you should not need to worry. In fact, the IRS has stressed that the adoption of AI won’t affect taxpayers earning below $400,000 a year.
But it’s another story if you’re a partner or high-income earner. If you earn more than $1 million, or are in a partnership with assets worth over $10 billion, you might find yourself in the AI spotlight. Especially if you have significant tax liabilities.
How the Technology is Being Used
AI tools basically allow the IRS to analyze huge sets of data to detect patterns of tax avoidance, make sure resources are allocated efficiently, and reduce unnecessary audits for compliant taxpayers.
One of the main ways to do this is by improving how returns are selected for review. Cases get evaluated against risk criteria, and those with a high likelihood of non-compliance are flagged for review.
So what data gets analyzed? Your tax filings, financial statements, and third-party reporting. Algorithms sift through this information to pinpoint anomalies, like unreported income, questionable deductions, or mismatched transaction records.
AI is also being used to improve IRS efficiency and operations and efficiency. This includes:
- Automated tax return processing: The IRS uses the Modernized e-File (MeF) system to extract data from paper tax returns. It’s more accurate and efficient than manual processing, and aims to reduce the huge backload of unprocessed returns.
- Detecting tax fraud: By scanning data sets through the Risk-Based Collection Model, the IRS can now identify patterns that may indicate fraudulent activity. The project has already helped them recover billions of dollars in unpaid taxes!
- Improved customer service: Through a new Virtual Assistant chatbot, which is available 24 hours a day, seven days a week, the IRS can help taxpayers resolve potential tax issues, and answer questions.
- Enhancing transparency: The IRS also needs to assure taxpayers that everything they’re doing is above board. As such, they’re using AI for more transparent and accountable tax administration.
At the same time, AI can help the tax authorities navigate intricate financial arrangements, like those of partnerships, international investments, and multi-entity businesses. It does this through cross-referencing data from various sources. That way, the agency can easily spot high-risk cases, and potential red flags like unexplained asset transfers, hidden accounts, or discrepancies in returns.
What This Means for High-Income Individuals and Large Partnerships
With a focus on wealthy individuals and partnerships, these two groups are the primary targets for AI algorithms. And that means a higher likelihood of being audited.
With this in mind, if you’re a high-income earner or in a partnership, you may need to reassess your tax strategy.
Basically, your tax planning must emphasize transparency, while ensuring accuracy and consistency to avoid AI triggers. And that means you’ll need to pay specific attention to how you report on the following:
- Multi-state and international property.
- Complex investment portfolios, including vehicles like trusts.
- Inconsistent or inaccurate data.
- Complicated partnership structures, like a tiered partnership.
- Estate or gift taxes with low- or no-tax transfers of assets to younger generations.
You may also face risks specific to your industry. Because of the intricate nuances of financial reporting in real estate, finance, and private equity, partnerships in these realms will be scrutinized more closely than ever. The same is true if you trade in digital assets like cryptocurrency.
Best Practices to Ensure Compliance
When filing your next tax returns, look out for stricter reporting and disclosure requirements. You’ll need to keep an eye out for any changes to tax regulations, and make sure you comply with them.
Alternatively, you can consult a tax pro to help you navigate any new reporting requirements. For instance, your partnership may need to provide clearer explanations for any discrepancies in financial statements. Or, if you have digital asset transactions, you may need more robust reporting than you did in the past.
It’s more important than ever to ensure your tax returns are accurate, submitted correctly, and filed on time. That means double-checking that all transactions are documented correctly.
And of course, remember that there’s a potential for an audit notice for high-income individuals and partnerships. If you do receive a notice, you must respond correctly and within the given deadlines.
When in doubt, get professional help
One of the best ways to ensure you don’t get caught out by the new AI compliance measures is to collaborate with tax professionals. Tax experts like the team at Fusion CPA help you navigate the evolving IRS requirements, identify potential risk areas in filings, and ensure that you always adhere to reporting guidelines.
For assistance with your tax filings, or creating a sound tax strategy for your business, schedule a free Discovery Call with our team.
The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.
