How AI is helping the IRS close the tax gap: Challenges & opportunities
The US tax gap – an enormous $688 billion in 2021 –represents taxes owed but not paid.
This persistent issue has far-reaching consequences, including underfunded programs, increased national debt, and added pressure on compliant taxpayers.
To address this challenge, the IRS is increasingly turning to artificial intelligence (AI) for modernized solutions.
Below, we explore the nature of the tax gap, the role of AI in addressing it, and the challenges that lie ahead.
What is the tax gap?
The tax gap is the difference between taxes owed and taxes paid.
It is divided into three categories:
- Underreporting: When taxpayers understate their income or overstate deductions. This accounts for 80% of the gap.
- Underpayment: Taxes are reported but not paid on time. This contributes 10% of the gap.
- Nonfiling: Taxpayers fail to file required returns altogether.
Recent trends in the tax gap:
- In 2014-2016, the average annual tax gap was $496 billion.
- By 2021, this figure surged to $688 billion, with underreporting as the primary driver.
How AI is transforming IRS operations
The IRS has started leveraging AI to address various aspects of the tax gap.
While not a complete solution, AI provides innovative tools to modernize tax compliance and improve efficiency.
Applications of AI in tax compliance
1. Annual audits
AI is being used to:
- Select a representative sample of taxpayers for audit.
- Identify returns likely to have errors or underreported income.
2. Refundable credits
AI models now help identify errors in claims for refundable credits, such as the Earned Income Tax Credit (EITC), improving accuracy and detecting high-risk returns.
3. Partnership audits
The increasing complexity of partnerships poses challenges for the IRS. AI helps prioritize which large partnership returns to audit by identifying high-risk cases among the growing number of these entities.
Benefits of AI in tax compliance
- Proactive error detection: AI can identify inconsistencies in real-time during tax filing.
- Improved audit outcomes: Automated selection enhances efficiency and ensures audits target high-risk cases.
- Resource optimization: By automating simpler cases, IRS personnel can focus on more complex issues.
Challenges in implementing AI at the IRS
Despite its potential, the IRS’s use of AI faces several hurdles:
Incomplete documentation
The IRS has not fully documented technical specifications for its AI models, leading to concerns about transparency and consistency.
Outdated infrastructure
The agency still relies on decades-old systems, which limits its ability to fully integrate AI and other advanced technologies.
Linking data to compliance efforts
The IRS has yet to align its Strategic Operating Plan (SOP) with specific tax gap data, missing an opportunity to refine compliance strategies effectively.
Future implications for taxpayers
With the IRS’s increasing reliance on AI, taxpayers should prioritize accurate reporting to avoid penalties.
Expats, in particular, may face unique complexities when navigating international tax obligations.
Tips for compliance:
- Keep accurate and detailed records.
- Stay informed about changes in tax laws and IRS enforcement strategies.
- Work with experienced tax professionals.
Closing thoughts
AI is reshaping the IRS’s approach to tackling the tax gap. While it offers significant promise in improving tax compliance and recovering lost revenue, the technology must be implemented transparently and in conjunction with a robust human oversight framework.
For expats, understanding these developments and working with seasoned professionals is essential to staying compliant in an evolving tax landscape.