As with many fields, artificial intelligence (AI) has significantly impacted tax reporting, benefiting both taxpayers and the IRS. AI has increased efficiency through automation and data analysis capabilities. AI can also streamline the review process by quickly identifying potential discrepancies or missing information within the tax return or documents, prompting users to address these issues proactively.
For taxpayers, this translates to improved accuracy and ensuring they claim all applicable tax credits and deductions. This saves time and minimizes the likelihood of costly errors that could trigger audits or penalties.
The IRS also benefits from these advantages. The IRS is increasingly leveraging the power of AI to reduce the number of taxpayers who fail to report, fail to file, or underreport their income, ultimately fostering greater tax compliance.
The IRS has already implemented AI-driven strategies, creating new efficiencies and unlocking greater productivity.
AI identifies taxpayers for potential audits. Using sophisticated algorithms, AI analyzes a vast array of data to assess the probability of errors within filed tax returns and identify taxpayers statistically more likely to owe additional taxes. AI's speed and efficiency enable the IRS to analyze a significant volume of tax returns compared to what was previously possible.
Advanced machine learning algorithms can analyze vast datasets of tax returns and financial information, identifying patterns and anomalies that might indicate misreporting. These algorithms can flag suspicious transactions, unusual deductions, or inconsistencies in reporting that would be difficult for human auditors to detect on their own. This increased analytical capacity may encourage greater tax compliance by taxpayers, knowing the IRS has more resources to identify misreporting.
The IRS also uses AI to help identify taxpayers who are not properly claiming refundable tax credits, such as the Earned Income Tax credit. While these credits are designed to provide financial relief to eligible taxpayers, ensuring they are accurate and properly claimed is vital.
In recent years, the prevalence of organizations filing as partnerships has increased, so the IRS is focusing AI efforts on the auditing of these partnerships. A primary advantage of the partnership structure lies in allowing partners to pass income or losses directly to their individual tax returns rather than having the entity itself subject to corporate-level taxation.
This structure, while legitimate, can also present complexities and opportunities for potential misreporting. Recognizing this, the IRS is using AI to analyze partnership filings, aiming to identify possible areas of non-compliance and ensure the accurate reporting of income and deductions within this increasingly common business structure.
However, like all AI resources, AI in tax reporting remains a work in progress and is not without limitations.
This is compounded by the tax code's inherent complexity, ambiguity, and intricate nature, as even the IRS acknowledges. The tax code encompasses a wide array of financial transactions, diverse legal frameworks, and unique circumstances that vary from one organization to another. And while AI demonstrates efficiency in processing straightforward W-2 tax returns, the complexities embedded within corporate, partnership, sole proprietorship, and 1099 employee tax filings pose significant challenges.
The tax code is not a binary system of black and white. It has gray areas where determining whether an entity qualifies for a specific tax benefit can become subjective. Tax positions often give rise to unique circumstances that differ considerably among taxpayers. That level of complexity and nuance is why having a professional review of tax returns is so important.
Adopting AI’s analytical capabilities provides mutual benefits for both taxpayers and the IRS. It enables taxpayers to claim their proper tax benefits and increases tax compliance. AI is a significant step towards a more efficient and effective tax system and will only continue to improve. The real question is how AI can come alongside humans to increase productivity and minimize mistakes. This is just the beginning.
