The Internal Revenue Service (IRS) informed us a few days ago of their plans to implement new Artificial Intelligence Systems making good on their promise of increasing audits on higher earning taxpayers, larger partnerships, and upper income corporations. This is just a small portion of their current plan implementing technology to go after what they call “millionaire tax cheats.”
Once fully implemented, the system will supposedly do a better job of catching previously missed taxpayer issues. The agency also reaffirmed their stance to not go after taxpayers earning less than $400K annually.
In order to fully understand why this is impossible, let’s review how the system works. Audits are generally initiated in two basic ways.
The Matching System
The IRS has a copy of the majority of your annual tax forms. They get copies of your W-2’s, 1099’s, 1098’s, and just about anything else that goes into your return.
When we file your return, the Service goes through a matching process where they confirm what we put on the return against what they already have on file. In this process they produce a “grade” for your return.
If enough things are missing and you get a low enough grade, they’ll either send out a correction letter or an auditor. It should be noted that both of these processes are considered an “audit” when the IRS presents its annual audit numbers.
If it’s a correction letter, then we’ll have time to reject their claim and send in whatever is necessary to prove that they are wrong. If it’s a full blown audit, then we’ll need the backup necessary to support our claims and get you through the audit unscathed.
The Algorithm
This process compares the tax returns of similar businesses in a similar geographic area. The process in concept is perfectly logical.
Why would they compare a General Contractor in Chicago to a CPA in Alabama? Nothing would match. They do this through comparing returns with geographically similar zip codes and similar SIC Codes or Standard Industry Classifications.
So lets say that we have two entrepreneurs in the same business that are also in the same zip code. The IRS compares their business returns. One taxpayer is honest, the other, not-so-much.
The honest taxpayer takes a deduction of 1% against their income for meals. The dishonest taxpayer takes a deduction of 10% for meals. This 10% deduction automatically “red flags” in the algorithm as being too large because everyone else in that business and zip code only takes a 1% deduction.
The return is then sent to a person at the Service who has to make a decision. Their choices are…
1 – Let it pass
Maybe the income on the dishonest taxpayer’s return was so low, that the deduction is reasonable.
2 – Do a Line Item Audit
These are sometimes called Correspondence Audits. They send out a letter asking for substantiation on a particular expense item. We in turn need to send in the cancelled checks, credit card statements, and whatever else it might take to prove that the expense is reasonable.
3 – Do a Full Audit
Here we’d need to explain the entire return to an auditor.
That’s how the system works. They currently do this on each and every return, no matter how large or small.
If they’re beefing up their existing technology in looking at returns, then how could they possibly only check the larger ones, when they’re already checking all of them? Are they trying to tell us that when they find a discrepancy on the tax return of a middle income family, that they’re just going to let it go?
This is the IRS. It’s a collection agency.
If you actually believe that they won’t go after that middle class family, I’ve got a bridge to sell you.
This makes the work we do in checking and double checking your returns that much more necessary. Verifying our work and maintaining your backup has become even more important.
Big Brother is on his way.
Let me leave you with this.
Today is September 15th. Partnership and S Corp returns that were on extension for 2022 are due today.
If you don’t file these returns by today’s close of business, you’ll be subject to penalties including but not limited to the dreaded Failure to File and Failure to Pay additions.
But we still have one more deadline ahead for the 2022 filing season. C Corp, Trust, Estate, and Individual Income Tax Returns that are on extension are due October 16th.
If you haven’t sent your work in on these, please get it to us at your earliest convenience. It would be a mistake to wait till the last minute.
We’re all going to get through this. Let’s get through it together.
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Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
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