AI, Audits, and the IRS: What Tax Pros Should Watch

AI is transforming tax preparation, but it's also creating new audit risks and compliance obligations. Here's what tax professionals need to know about IRS expectations, documentation requirements, and liability when using AI tools.

Why the IRS cares about AI in tax prep

The IRS is paying close attention to AI use in tax preparation because it affects return accuracy, professional standards, and taxpayer protection. Tax professionals using AI face new responsibilities:

• Due diligence obligations → Ensuring AI-prepared returns meet accuracy standards
• Documentation requirements → Maintaining records of AI tool use and validation
• Professional liability → Responsibility for AI errors and omissions
• Client disclosure → Informing clients about AI use in their returns
• Audit defense → Explaining AI-assisted work to IRS examiners

Current IRS position on AI in tax preparation

Professional standards still apply

The IRS expects the same accuracy and due diligence regardless of AI use:

• Circular 230 compliance → AI doesn't change professional conduct requirements
• Due diligence standards → Tax pros must verify AI-generated work
• Accuracy-related penalties → AI errors don't excuse professional liability
• Client representation → Tax pros remain responsible for all return positions

Documentation expectations

IRS guidance on AI documentation requirements:

• AI tool identification → Record which AI systems were used
• Validation procedures → Document review and verification steps
• Decision rationale → Explain professional judgment in AI-assisted work
• Client communications → Record AI disclosure to clients
• Quality control → Document AI oversight and error correction

Audit implications

How AI use affects IRS examinations:

• Increased scrutiny → AI-prepared returns may face higher audit rates
• Documentation requests → IRS may ask for AI tool information
• Professional competence → Demonstrating understanding of AI limitations
• Penalty exposure → AI errors affecting penalty calculations

Common AI tax preparation risks

Data accuracy and completeness

AI systems can misinterpret or miss critical tax information:

• Document scanning errors → OCR mistakes in reading tax documents
• Data classification issues → AI mischaracterizing income or deduction types
• Missing information → AI failing to identify required disclosures
• Context misunderstanding → AI not grasping unique client circumstances
• Calculation errors → Mathematical mistakes in complex computations

Tax law interpretation

AI limitations in applying complex tax regulations:

• Regulatory updates → AI training data may not include latest changes
• Fact-specific analysis → AI struggling with unique factual situations
• Professional judgment → AI cannot replace human expertise in gray areas
• Aggressive positions → AI may suggest questionable tax strategies
• State and local variations → AI errors in multi-jurisdiction returns

Client-specific considerations

AI challenges with individual taxpayer circumstances:

• Business structure complexity → AI misunderstanding entity relationships
• Investment transactions → AI errors in basis calculations or character
• International issues → AI mistakes in foreign tax credit computations
• Estate and gift planning → AI missing valuation or timing issues
• Special circumstances → AI not recognizing unique taxpayer situations

IRS audit scenarios involving AI

Scenario 1: AI misclassifies business expenses

Situation: AI tool categorizes personal expenses as business deductions

IRS examination focus:

• Documentation supporting business purpose
• Tax preparer's review procedures
• Client interview and verification steps
• AI tool training and accuracy testing
• Professional judgment in expense classification

Potential outcomes:

• Disallowed deductions and additional tax
• Accuracy-related penalties on taxpayer
• Preparer penalties for unreasonable positions
• Professional conduct investigation
• Requirement for enhanced procedures

Scenario 2: AI calculation error in depreciation

Situation: AI incorrectly calculates Section 179 deduction limits

IRS examination focus:

• Accuracy of depreciation computations
• Compliance with Section 179 limitations
• Tax preparer's verification procedures
• AI tool testing and validation
• Professional competence in tax software use

Potential outcomes:

• Adjustment to depreciation deductions
• Recapture of excess deductions
• Interest on underpayment
• Preparer accuracy penalties
• Client relationship damage

Scenario 3: AI fails to identify reporting requirements

Situation: AI misses FBAR or Form 8938 filing obligations

IRS examination focus:

• Foreign account reporting compliance
• Client interview and disclosure procedures
• Tax preparer's due diligence steps
• AI tool capabilities and limitations
• Professional responsibility for compliance

Potential outcomes:

• Significant FBAR penalties
• Form 8938 failure-to-file penalties
• Criminal referral for willful violations
• Preparer sanctions and penalties
• Professional license implications

Best practices for AI use in tax preparation

AI tool evaluation and selection

Criteria for choosing appropriate AI tax software:

• Accuracy testing → Validate AI performance on sample returns
• Training data quality → Understand AI model training and updates
• Error detection → AI ability to flag potential mistakes
• Audit trail → Documentation of AI decision-making process
• Professional support → Vendor assistance with complex issues
• Regulatory compliance → AI tool adherence to tax regulations

Implementation procedures

Structured approach to AI integration in tax practice:

1. Pilot testing → Test AI tools on known returns before full deployment
2. Staff training → Educate team on AI capabilities and limitations
3. Quality control → Establish review procedures for AI-prepared work
4. Documentation standards → Create records of AI use and validation
5. Client communication → Develop AI disclosure procedures
6. Error correction → Establish processes for identifying and fixing AI mistakes

Ongoing monitoring and validation

Continuous oversight of AI tax preparation:

• Regular accuracy testing → Periodic validation of AI performance
• Error tracking → Monitor and analyze AI mistake patterns
• Software updates → Stay current with AI tool improvements
• Regulatory changes → Ensure AI reflects latest tax law updates
• Professional development → Maintain competence in AI tax tools

Documentation requirements for AI-assisted returns

AI tool documentation

Records to maintain about AI software use:

• Software identification → AI tool name, version, and vendor
• Configuration settings → AI parameters and customizations
• Training data → Information about AI model training
• Accuracy testing → Results of AI validation procedures
• Update history → Record of AI software updates and changes

Return preparation documentation

Records specific to each AI-assisted return:

• AI involvement → Which return sections used AI assistance
• Review procedures → Steps taken to validate AI work
• Professional judgment → Areas where human expertise overrode AI
• Client communications → AI disclosure and client consent
• Quality control → Supervisory review of AI-prepared work

Client file documentation

Client-specific records for AI use:

• AI disclosure → Written notice to client about AI use
• Consent documentation → Client agreement to AI assistance
• Limitation explanation → Discussion of AI capabilities and risks
• Alternative options → Client choice between AI and traditional preparation
• Professional responsibility → Clarification of preparer liability

Professional liability and AI errors

Preparer responsibility standards

Professional liability for AI-assisted tax preparation:

• Due diligence obligation → Must verify AI work meets professional standards
• Competence requirement → Must understand AI tool capabilities and limitations
• Supervision duty → Must oversee AI-generated work appropriately
• Error correction → Must identify and fix AI mistakes
• Client protection → Must ensure AI serves client's best interests

Common liability scenarios

Situations where AI use creates professional liability:

• Negligent AI selection → Using inappropriate or unreliable AI tools
• Inadequate validation → Failing to properly review AI work
• Incompetent use → Misunderstanding AI capabilities or limitations
• Disclosure failures → Not informing clients about AI use or risks
• Supervision lapses → Inadequate oversight of AI-assisted work

Risk mitigation strategies

Approaches to reduce AI-related professional liability:

• Comprehensive training → Ensure staff competence in AI tools
• Robust procedures → Establish thorough AI validation processes
• Clear documentation → Maintain detailed records of AI use and review
• Client communication → Transparent disclosure of AI involvement
• Insurance coverage → Verify professional liability insurance covers AI errors
• Continuous monitoring → Regular assessment of AI performance and risks

Client communication about AI use

Disclosure requirements

Information clients should receive about AI in tax preparation:

• AI involvement → Which aspects of return preparation use AI
• Benefits and limitations → AI capabilities and potential risks
• Professional oversight → Human review and validation procedures
• Data security → How client information is protected in AI systems
• Alternative options → Choice between AI-assisted and traditional preparation

Consent and agreement

Client consent process for AI use:

• Written disclosure → Formal notice of AI use in engagement letter
• Informed consent → Client understanding of AI implications
• Opt-out option → Client choice to decline AI assistance
• Liability clarification → Professional responsibility regardless of AI use
• Ongoing communication → Updates about AI involvement during preparation

Managing client expectations

Setting appropriate expectations for AI-assisted tax preparation:

• Accuracy standards → AI doesn't guarantee error-free returns
• Professional judgment → Human expertise remains essential
• Complexity limitations → AI may not handle unique situations well
• Review requirements → Client responsibility to review AI-prepared work
• Audit implications → Potential for increased IRS scrutiny

Preparing for IRS examinations with AI

Audit preparation checklist

Steps to prepare for IRS examination of AI-assisted returns:

1. Gather AI documentation → Compile records of AI tool use and validation
2. Review professional procedures → Document compliance with due diligence standards
3. Prepare explanations → Develop clear descriptions of AI involvement
4. Identify expert witnesses → Arrange for AI technical expertise if needed
5. Organize client files → Ensure complete documentation of AI disclosure and consent

Responding to IRS information requests

Handling IRS inquiries about AI use in tax preparation:

• AI tool identification → Provide specific information about software used
• Validation procedures → Explain professional review and verification steps
• Training documentation → Demonstrate staff competence in AI tools
• Quality control → Show systematic oversight of AI-assisted work
• Professional judgment → Highlight human expertise in return preparation

Defending AI-assisted positions

Strategies for supporting AI-prepared return positions:

• Technical accuracy → Demonstrate correct application of tax law
• Professional standards → Show compliance with due diligence requirements
• Documentation support → Provide comprehensive records and explanations
• Expert testimony → Use AI specialists to explain technical aspects
• Precedent analysis → Reference similar cases and IRS positions

See our SEC disclosure guide for related compliance considerations.

Questions to ask yourself

1. Do we have adequate procedures to validate AI-prepared tax work?
2. Are we properly documenting AI use and professional review for audit defense?
3. Have we disclosed AI involvement to clients and obtained appropriate consent?
4. Do our staff have sufficient training and competence in AI tax tools?
5. Are we prepared to defend AI-assisted return positions in IRS examinations?