How The IRS Uses Artificial Intelligence To Catch Tax Fraud

How The IRS Uses Artificial Intelligence To Catch Tax Fraud

According to the IRS, Americans cheated the government out of more than $400 billion last year; put differently, one out of every six dollars payable to the IRS is lost. The amount lost by the government every year is estimated to be almost 75% of the annual federal budget deficit.

Despite this, the prosecutions of criminal tax evasion are declining every year, with tax fraud cases in 2017 down almost 25% on 2010 levels.

The bad news for cheats is that the IRS is now starting to employ technology to identify fraudsters.

Graph Databases?

Graph databases are used to do real-time analysis on big data, something that makes it possible for Netflix for example, to offer a personalized recommendation to you on what to watch. Now, the IRS is interested in the same technology to figure out who is cheating them.

Tax Evasion is Going Global

Money can now be moved across the world at the speed of light – literally. This fueled global growth for decades and opened the door for the bad as well. It makes it possible to commit tax fraud on a worldwide scale. It is as easy as ordering a pizza to set up shell corporations and make encrypted phone calls to represent paper corporations as legitimate business enterprises. The existence of global safe havens in locations like the Bahamas and Panama, where legal protections protect these shadow operations from being exposed to tax authorities, makes matters even worse for enforcement agencies.

Service-Crime Shell Corporations

By definition, a shell corporation is an entity created to hide revenue and to avoid taxes payable. Professional criminals provide financial services to tax avoiders. They incorporate new companies, offer fake directors to the cheat to hide behind, and offer laundering services to reroute the now reborn income back to its origin completely undetected. The brilliance of the perpetrators does not stop there. Now and then the corporations and its vast network of subsidiaries are disconnected when the subsidiaries are winded down and closed. It, therefore, becomes impossible to keep track of the movement of the funds. The pattern of deceit is hidden behind layers and layers of data/information.

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Fraud investigations struggle to roll back all the layers of data, and rarely succeed in penetrating more than three levels of data using traditional relational databases. It is just too time-consuming, and it requires so much computing power that it is unaffordable.

What is required to unmask these schemes are the ability to roll back the structure of these corporate entities with three or more layers, contemporaneous with a temporal analysis (identifying structural changes over time) and then red-flagging patterns where subsidiaries are used for a short time to route money before disappearing.

Beware of the New Generation of Native Parallel Graph Databases with Analytics

These new ‘virtual machines’ can dig ten levels and deeper into the money trail. It can identify shell corporations with duplicate addresses or contact details, mutual directors, and even those created or run from the same group of IP addresses. Temporarily, it can analyze complex hierarchies of corporations and identify the subsidiaries that exist only for short periods to pass funds back and forth between related accounts and identify networks of entities who seem to only transact with one another all the time.

What is more, this machine it can connect to multiple sources – including the world’s largest databases of corporate information, to aid in its quest to connect and identify mutual directors, addresses, phone numbers, and contact details.

And to crown it all, it can follow the money through more than ten “hops” (accounts), keep track when it loops back using just as complex a pattern of deceit, and red-flag patterns that suggest tax evasion, all because of its massively parallel processing of the native parallel graphs.

If you are a tax crook, watch out. The machine is looking for you as we speak. The IRS is once again, everywhere you look.

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How The IRS Knows If You Cheat On Your Taxes

Here’s one to keep you awake at night

All the information returns that stack up in your office around tax time is not your secret alone. Everyone at the IRS knows about it too. Most senders of the little forms that record the various payments you made during the year, and all those heart-warming notices that confirm deposits that were made to you are likely duplicated into the inbox way out there in IRS land.

If you thought these forms were trivial and prefer to toss it rather than confusing your ‘financial narrative’ when you file your W-2s (wages earned from job) and 1099s (payment for freelance work and earning from dividends and interest, you’d better think again.

Big Brother is watching

And that is not all. Even if you take distributions from your retirement account, benefit from unemployment compensation or win a small cash prize – even if you withdraw money from your college fund – or sell some stock, also if a debt you owe is canceled or if you finally pay off your mortgage, the IRS will be there, reading their little information returns about your transactions as they slowly appear in their inbox.

But why do they care?

They care. Very much. These apparently benign pieces of paper allow the IRS to build a profile of your financial life, which they can use to compare to what you disclose to them. Small omissions on your side will be flagged, and from then on, you are on their radar.

It will start with a standard letter that puts you to proof. A disparity they will say, is apparent. According to their records, you earned more income than you reported, so you owe them. If you disagree, they await your reply and corrections. No amount is too trivial for the IRS – they do this even for tiny amounts of money.

Be pro-active

If your employer’s W-2 to you overstates your income, do not ignore it and try to solve the problem by merely reporting the correct amount on your tax return. Ask your employer for a correction before you have to contradict their version to prove your point.

If you discover omitted information after you filed your returns, submit a do-over IRS Form 1040X to amend your tax return, but get it in before you receive a notice from the IRS, if you can.

Read before you think before you pay

Most people are nervous compliers, so when they receive a notice from the IRS that claims they owe more based on discrepancies in their tax returns, they tend to pay without question – anything to make the IRS go away. This is unwise. The IRS might have a point, but they can be mistaken too. The answer is in the fine print, as they say. Double-check whether you indeed omitted whatever they infer you did.

Very often, the nomenclature on your tax return differs slightly from the information return they are referring to. The IRS matching is not perfect, and in the majority of cases, they are wrong. If so, just help the IRS to locate the match.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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Fulton Abraham Sanchez, CPA

Fulton Abraham Sánchez, CPA I am Certified Public Accountant, specialized in Tax Planning & Offshore Strategies for Real Estate, Hedge/Equity Funds, Fintech, Crypto, Expats, IRS Debt Resolution. You can email me and follow us on Facebook : FAS CPA & Consultants.

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