Could AI Help the IRS Audit You?

The Internal Revenue Service has launched a new initiative using artificial intelligence to detect and penalize tax evasion amongst 75 hedge funds, private equity groups, real estate investors, and law firms, according to multiple news outlets, including the Wall Street Journal and The New York Times. The initiative is designed to put some of the $80 billion allocated to the agency under the Inflation Reduction Act to use after bolstering its full-time staff to nearly 90,000 people.

The cases against these partnerships and investment groups are particularly complex and cumbersome. While the additional staffing will help, sophisticated AI programs designed in-house promise to significantly bolster and streamline the audit process. As part of the initiative, the IRS also sought to hire data scientists to help develop custom AI applications to analyze tax returns and aid in audits.

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IRS Commissioner Danny Werfel emphasized that the new initiative, and the technology powering it, will be designed to target the highest-income earners, not middle-income taxpayers. “This new compliance push makes good on the promise of the Inflation Reduction Act to ensure the IRS holds our wealthiest filers accountable to pay the full amount of what they owe,” Werfel told Forbes. “The years of underfunding that predated the Inflation Reduction Act led to the lowest audit rate of wealthy filers in our history.”

The current initiative identified and seeks to audit 75 of the largest partnerships in the U.S., each with more than $10 billion in assets. Five hundred additional partnerships will receive notices. Depending on the response, these companies could also be added to the audit list.

“The deployment of AI and machine learning technologies allows the IRS to sift through massive volumes of tax returns and related data with an unprecedented level of detail and accuracy,” explained Brian Prince, CEO of TopAITools.com. “This technology can identify patterns and anomalies that might indicate errors or fraudulent activity that would be difficult, if not impossible, for human auditors to detect through traditional methods.”

Pros and Cons of AI Implementation in the IRS

An increase in audits on the higher end of the income tax bracket, aided by AI, could help reduce the income gap. Studies show that the wealthiest people in the U.S, including billionaires, pay just 2% of their total income in taxes, thanks to tactics like offshore tax havens and real estate investments.

“AI can rapidly sort through vast amounts of data to detect illegal or suspicious activities that could indicate tax evasion or fraud,” Prince said. “It can also forecast trends and identify new ways wealthy business owners and investors can dodge taxes. This can enable lawmakers and the IRS to tailor new compliance strategies, essentially staying ahead of those who try to evade taxes.”

While AI can help streamline IRS audit processes and help ensure the wealthy 1% pay their fair share of taxes, dangers exist. “As with so many aspects of introducing AI into mission critical operations, we must be aware of introducing biases or blindly accepting AI’s conclusions,” Prince said.

This is especially concerning since lower-income individuals who claim the Earned Income Tax Credit remain at greater risk for an audit than middle-income taxpayers. Data from the Congressional Research Service indicated that 0.78% of audits occurred on EITC tax returns. The lion’s share, however, targets higher income taxpayers earning $1 million or more.

George Baseluos, founder and CEO of Alleviate Tax, acknowledged, “The introduction of AI into IRS audit processes could lead to a higher chance of an audit on the lower and higher ends of the income spectrum.”

Are You At Risk for An Audit?

In spite of promises from the IRS that the increased staffing and new technology will not increase audit rates beyond pre-IRA historical lows for lower- and middle-income taxpayers, a well-funded IRS could mean a scarier IRS for some demographics.

“AI implementation by the IRS is likely going to facilitate and increase collection activity. I think the likely scenario is they would use AI to determine trends and ‘assume’ income in the absence of proper reporting or a recent tax filing,” Baseluos stated. “That could lead to issues, especially for business owners,” he added.

Because business income may not be stable, instead showing ebbs and flows in profitability, AI could mistakenly flag a business for an audit because the business had a down year and showed less income, Baseluos explained. The business wasn’t hiding income, as the AI algorithm may have assumed, but rather fell upon a difficult time.

How AI Can Help You

On the other hand, using AI in your own tax filings or even for tax planning can have tremendous benefits.

“AI can process large amounts of tax-related data quickly, reducing human errors and ensuring a more accurate tax return. It can also identify deductions and credits that individuals might overlook, potentially saving money,” Prince previously told GOBankingRates.

Baseluos shared that he has already implemented Gen AI in his tax debt relief company. “AI assists our agents when they’re on consultation calls with clients or prospects. Generative AI tools ‘nudge’ our agents with onscreen prompts to ask specific follow-up questions that may not be part of the usual process, in an effort to discover more details, data, and information that can help our clients get the most effective tax resolution possible,” he said. “It’s meant to assist and support our human experts, not replace them.”

Final Take

In short, AI can help the IRS audit you. But, in reality, under the new policies, you should be no more at risk of an audit than you were previously.

If it happens and you get that dreaded notice, Baseluos offered this advice: “Don’t panic. Make sure to locate receipts and tax statements showing valid deductions. And don’t hesitate to enlist the help of tax experts if necessary.”

This article originally appeared on GOBankingRates.com: Could AI Help the IRS Audit You?