Beyond the Hype: The Reality of AI in Tax Compliance

Artificial intelligence (AI) is transforming the tax compliance landscape, helping tax authorities streamline operations, improve taxpayer services, and enhance fraud detection. Tax authorities like the IRS are actively leveraging AI in their compliance efforts, fueled by resources from the Inflation Reduction Act. This blog explores the ways AI is shaping tax compliance, provides practical applications and a look at what lies ahead for tax authorities committed to harnessing AI’s power.

The Rise of AI in Government

AI’s potential to transform tax compliance is recognized by tax authorities worldwide, especially as governments manage vast volumes of taxpayer data that could reveal non-compliance patterns. With increased funding from the Inflation Reduction Act, the IRS has launched an ambitious initiative aimed at restoring fairness to the U.S. tax system. This effort prioritizes high-income individuals and large corporations, using AI to pinpoint discrepancies and enforce compliance.

A recent IRS initiative targets high-income non-filers, a group that includes individuals with significant financial activity who have failed to submit tax returns. This project involves 125,000 cases with high-income individuals, including millionaires, whose combined financial activity exceeds $100 billion. The IRS is applying AI and data analytics to identify these individuals, streamline case selection, and enhance efficiency in compliance. (IRS Newsroom)

The U.S. Government Accountability Office (GAO) supports the use of AI to help close the tax gap or the difference between taxes owed and collected. The GAO has advised the IRS to leverage AI for fraud detection and risk assessment, where AI’s ability to process massive datasets and find inconsistencies could greatly aid in identifying tax evasion. (GAO Blog)

AI in Action

The IRS’s application of AI demonstrates the technology’s effectiveness in improving compliance:

· Targeting High-Income Taxpayers: The IRS has introduced initiatives that focus on high-income earners and large corporations, using AI to uncover complex tax evasion tactics often used by these groups. AI-driven automation allows the IRS to analyze large corporate and partnership structures to identify cases where taxes may have been underreported.

· AI for Partnership Audits: Large partnerships present unique compliance challenges due to their complex structures and high transaction volumes. With the support of the Inflation Reduction Act, the IRS is utilizing AI to simplify partnership audits, facilitating the identification of discrepancies and non-compliance in a sector historically difficult to audit. (IRS Newsroom)

· IRS Strategic Operating Plan: The IRS’s strategic operating plan underlines the significance of AI and data analytics in modernizing tax enforcement. The plan outlines how new technologies, including AI, will help the IRS meet its long-term goals of improving audit selection, reducing processing times, and enhancing the taxpayer experience. (IRS Strategic Operating Plan)

These initiatives highlight AI’s role in enabling more efficient audits, allowing the IRS to allocate resources to high-priority cases, and increasing compliance across sectors.

Current Practical Use Cases for AI in Tax Authorities

AI provides valuable applications for tax authorities, enhancing compliance and taxpayer services:

· Taxpayer Assistance: AI-powered chatbots used by the IRS and other tax authorities handle taxpayer inquiries, providing quick responses to frequently asked questions. This reduces customer service demands and ensures taxpayers receive timely guidance, especially during high-demand seasons.

· Data Analysis for Audits: The IRS uses AI to support data analysis in audit processes. AI-driven tools allow auditors to process vast datasets, quickly identifying patterns or anomalies that might indicate non-compliance. For example, AI can cross-check tax forms with third-party sources to flag inconsistencies, focusing audits on high-risk cases.

· Fraud Detection: AI algorithms play a significant role in identifying fraudulent activity. The IRS employs AI to spot suspicious patterns, such as underreported income or exaggerated deductions, by scanning for markers of evasion. This automated detection accelerates case processing and enables agents to act faster on suspected fraud.

· Revenue Forecasting: AI’s predictive models improve revenue forecasting, helping tax authorities anticipate tax collections more accurately. By analyzing economic indicators and taxpayer behaviors, AI-driven forecasting models inform budget allocations and resource planning.

· Force Multiplier for Investigations: In MeriTalk’s interview with IRS-CI Cyber Chief Jarod Koopman, AI is a force multiplier for investigations: “One of the most significant ways IRS-CI is using AI is by leveraging machine learning to analyze vast amounts of data. ‘Think about the amount of data that we have – from our operational [data] mixed with open-source intelligence – if there’s a way that we can leverage AI to look at all of that to find pattern or to highlight things that are really nefarious or criminal in nature, it just makes us much more efficient in our job.’ Koopman notes that AI is “getting more efficient at drilling down into the most egregious cases,” whereas previously, it was like 'throwing darts.'"

These use cases demonstrate how AI enables the IRS to boost efficiency, enhance compliance, protect revenue, and streamline taxpayer support functions.

Future-Proofing Tax Systems with AI

As tax systems become more complex, AI offers a path to future-proof compliance. The IRS’s strategic operating plan highlights the agency’s commitment to using advanced technology to address modern tax challenges and make tax administration more efficient. AI’s ability to handle high-volume data processing tasks positions it as a powerful tool for tax authorities, particularly for areas like risk-based audits and taxpayer assistance.

Strategic AI investments allow tax authorities to optimize resource allocation, focus on data-driven decision-making, and bolster compliance. By using AI to manage routine tasks and deliver actionable insights, the IRS and other tax authorities are modernizing their operations, preparing them to better address tax compliance in an increasingly digital world.

Final Thoughts: Is Now the Right Time?

While AI’s benefits in tax compliance are evident, implementing these technologies presents challenges. The IRS’s phased approach to AI adoption reflects a cautious and calculated strategy, prioritizing areas where AI can yield the most immediate value. This approach not only maximizes AI’s potential but also allows the IRS to navigate regulatory and security concerns gradually.

The GAO’s recommendation for AI adoption in the IRS underscores AI’s potential to reduce the tax gap. However, effective AI implementation requires careful planning and secure data management to ensure taxpayer privacy. As tax authorities worldwide consider adopting AI, they must weigh automation’s advantages against the importance of data security and regulatory compliance.

AI’s role in tax compliance is expected to grow, and as it advances, tax agencies have much to gain from its adoption. With informed, strategic investments, tax authorities like the IRS are positioning themselves to drive compliance, enhance taxpayer experiences, and create a more transparent and fair tax system.

To learn more about how IVIX is helping tax authorities successfully leverage the benefits of AI, request a demo today.

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