IRS Compliance Efforts Target Pass-Through Entities, Expand Use of AI in Tax Audits by Joseph Leocata, JD, CPA, MBA
Posted on November 01, 2024
by
Joseph Leocata
The IRS recently launched a new unit committed to enforcing U.S. tax laws among pass-through entities, such as S corporations, partnerships and trusts, whose income passes from the business to its owner’s individual tax returns where taxes are due at the owners’ marginal income tax rates. The move is part of the agency’s broader focus on expanding tax compliance among big businesses, complex partnerships and high-net-worth individuals with more than $400,000 in annual income. With the new unit, the IRS will assemble revenue agents into geographically based teams that are responsible for primary exams of pass-through entity returns,
After receiving a commitment of $60 billion in federal funding under the Inflation Reduction Act of 2022, the IRS outlined a 10-year strategic plan to improve taxpayer services, increase its staff of skilled workers and invest in cutting-edge technology, data and analytics. It also set an auspicious goal to expand compliance enforcement and address the tax gap or the difference between the amount of taxes owed and paid. Current projections call for the gross tax gap to increase to $688 billion in 2021, including tax return nonfilings, underreporting of tax liabilities and underpayment of taxes due.
One tool the agency is continuing to invest in to achieve these aims is artificial intelligence (AI), which uses machine learning algorithms to quickly process and analyze large amounts of data, extract relevant information, identify patterns and anomalies, and make predictions of future outcomes. According to IRS Commissioner Danny Werfel, AI is like “night vision goggles” that help spot issues in tax returns involving the “most complicated, largest taxpayers.” He also likened enforcement efforts to a chess game in which AI makes the agency a far better player.
In 2023, AI helped the IRS recover $1.3 billion in overdue taxes from reticent taxpayers. By 2026, the agency expects its use of AI to more than double the number of individual and corporate taxpayers it selects for audits. Taxpayers can prepare for this increased scrutiny by recognizing some of the common anomalies AI identifies that can trigger an audit and taking steps to remedy them before filing their annual returns. They include the following:
- Claiming significantly higher than average income, loss or deductible expenses in a particular tax year
- Claiming incorrect or unsupported business expenses, including business meals and entertainment, business use of an automobile and Section 179 deduction for depreciable business equipment
- Failing to disclose foreign financial accounts and file Reports of Foreign Bank and Financial Accounts (FBARs)
- Dealing with cryptocurrency
If you are selected for an IRS audit, do not panic. Contact your CPA and tax advisors with experience representing taxpayers in these examinations. They can be a valuable source to help you gather important documents and prepare supporting information the IRS will expect you to provide.
About the Author: Joseph Leocata, JD, CPA, MBA, is a senior manager of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where he works with individuals and businesses on a broad range of federal, state and local tax issues, including representation before the IRS on tax controversy matters. He can be reached at the CPA firm’s New York City office at (646) 213-7600 or info@bpbcpa.com.
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