On 10/12/23, the IRS announced new tax gap projections for tax years 2020 and 2021 showing the projected gross tax gap increased to $688 billion in tax year 2021, a rise of more than $192 billion from the prior estimates for tax years 2014-2016 and a rise of $138 billion from the revised projections for tax years 2017-2019. The U.S. Government Accountability Office (GAO) states that IRS use of AI can provide additional tools to help IRS better understand and estimate the tax gap as per the 6/6/24 Report.
The gross tax gap covers three key areas:
- Nonfiling, which means tax not paid on time by those who do not file on time: $77 billion in tax year 2021, up from $41 billion in tax years 2017 to 2019 – an 88% increase.
- Underreporting, which reflects tax understated on timely filed returns: $542 billion in tax year 2021, up from $445 billion in tax years 2017 to 2019 – a 21% increase.
- Underpayment, or tax that was reported on time, but not paid on time: $68 billion in tax year 2021, up from $64 billion in tax years 2017 to 2019 – a 6% increase.
IRS use of AI is helping close the tax gap
The GAO Report states that besides AI helping to identify taxpayers who are most likely to skip out or not pay the taxes that they owe, the IRS use of AI is currently in use as per the following extracts from the Report:
- Annual audits. Each year, IRS selects a group of taxpayers to audit as part of its research into tax compliance trends. AI models are already being used to help select a representative sample of the taxpayer returns to audit. AI is also being used to identify returns that are more likely to have errors and are more likely to owe additional taxes. After these audits, IRS creates an estimate of the tax gap. This is important for helping IRS to better understand situations in which taxpayers aren’t complying with tax laws.
- Refundable credits. IRS uses both manual processes and AI to help select taxpayers claiming refundable credits, such as the Earned Income Tax Credit, for audit. IRS plans to use a new AI model to help it identify taxpayers for audit that are more likely to owe additional taxes.
- Partnership audits. More businesses are being organized into partnerships, which allows them to pass income and losses to their partners instead of being taxed as corporations. The number of large partnerships has increased in recent years (by 600% between 2002 and 2019). This shift has made it more difficult for the IRS to identify taxable income and catch potential tax cheats.
- IRS audits few large partnerships’ tax returns because they are complex. IRS currently uses two AI models to help prioritize partnership returns for audit. The models are intended to help select the highest risk large partnership returns for audit.
The new IRS compliance efforts are geared towards having the IRS compliance teams better detect tax cheating, identify emerging compliance threats, improve case selection tools, and reduce the tax gap. The IRS efforts include:
- Prioritization of high-income cases in the High Wealth, High Balance Due Taxpayer Field.
- Expansion of pilot focused on largest partnerships leveraging Artificial Intelligence.
- Greater focus on partnership issues through compliance letters.
- Compliance efforts to address abusive micro-captive insurance arrangements and syndicated conservation easement abuses.
- Expanded work on digital assets.
- More scrutiny on FBAR violations.
- Adress labor brokers and ensure proper employment tax withholding.
- Protect taxpayers and businesses from aggressive scams and schemes and ensure audit fairness.
- Improved equity in audits.
- Protection against identity theft.
- Working with businesses and partner groups through a variety of education and outreach efforts.
- Strengthen cybersecurity protections and information technology systems.
IRS use of AI will assist the IRS in estimating undetected noncompliance and information on its root causes
Selecting tax returns that represent a cross section of industries including hedge funds, real estate investment partnerships, publicly traded partnerships, large law firms, high net worth individuals and other industries is a reality with the IRS use of AI.
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