Artificial Intelligence and IRS Audits: Who is in Control?
09/19/2023
William Stromsem, CPA, J.D., George Washington University School of Business
We knew it was coming, but we did not know when or what it was going to look like. The IRS clearly will use artificial intelligence (AI) in selecting tax returns for audits and in analyzing more complex returns. With its accelerating level of knowledge, we do not know where AI will be in a month, six months or a year, but we have some temporary indications.
The IRS has been using computers to select returns for many years and has been contracting with data-mining services for several years to identify unreported income. In the past, the discriminant income program—the DIF—looked for returns that were out of the ordinary for potential audit, but AI is qualitatively different in its power and scope. It has the potential for intrusive queries in selecting taxpayers for audit, such as inquiries into social media or other databases.
For example, social media might show lavish vacations and other databases might be queried for online money transfers, virtual currency transactions, foreign investments and bank accounts, online vacation home rentals or purchases of luxury items like cars, yachts, private planes or vacation homes. This information could be used to identify individuals who are living expensive lifestyles that are out of line with their reported incomes. In effect, AI will allow the IRS to do a “lifestyle audit” in selecting a return without an auditor having to do an actual field exam. We do not know what databases will be used and more data is being absorbed by AI daily.
The IRS is currently working on applying AI to selecting and analyzing large partnership returns for audit in 2024. By identifying common abuse facts and issues for AI, the computer can train itself to evaluate complex transactions and issues that may reflect abuses in such areas as partnerships with international connections that are identified in the new required K-2 and K-3 information returns. It can sift through thousands of pages of a complex partnership in seconds, work that previously might have taken many human work-years and might not have been undertaken because of limited resources. This will be a major augmentation of resources in the IRS’ Large Partnership Compliance program and in reviewing complex returns of hedge fund returns, private equity groups and REITs. In recent years, the IRS has been criticized for the low level of large partnership audits, and selection and analysis of returns by AI could rapidly expand these audits.
On the Plus Side
- AI will provide the cover of science in the audit selection process, rather than possibly reflecting human value judgments that in the past have led to problems where audits have, at times, seemed to have been targeted for certain groups for political reasons.
- AI could help identify situations where less sophisticated selection processes might have incorrectly selected a return for an unnecessary audit when a closer look would have shown legitimately reported income and deductions. This will save time and trouble for the IRS and the taxpayer.
Concerns
- What will be the quality of information in the databases? The IRS is currently using money from the budget increase in the Inflation Reduction Act of 2022 to hire or contract with AI experts and data managers. We do not know to what extent it will develop its own AI software and databases, and whether it will also use external AI programs.
- Using external AI has the risk of taxpayer information being absorbed by the AI program being used.
- What if there are errors in the database that target incorrect returns for audits?
- Will humans structure the queries for searching these databases or will AI learn to structure its own queries?
- What will be the level of human review (and control) of the audits selected using AI?
- Who will direct or redirect programs, and to what extent will humans be involved rather than the AI evolving on its own?
- What if AI targeting sweeps in too many compliant taxpayers?
- Will AI conduct actual audits in the future, corresponding back and forth with taxpayers?
This may make you feel like you are somehow trapped in a frightening dystopian science fiction novel where machines run society. But the future will come and we can only try to be as prepared as possible. The AI cat is out of the bag and its use by the IRS is inevitable, giving us all an uncomfortable feeling.
Quotes from the HAL 9000, the rogue computer that takes over the ship in “2001 A Space Odyssey”—
- “No 9000 computer has ever made a mistake or distorted information. We are all, by any practical definition of the words, foolproof and incapable of error.”
- “This mission is too important for me to allow you to jeopardize it.”
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