How State Tax Officials Utilize AI to Target Affluent Taxpayers

State tax officials are becoming increasingly aggressive in their audits of high-earning individuals, utilizing artificial intelligence (AI) to target affluent taxpayers. This trend is particularly evident in New York, where the number of audits conducted by the tax department increased by 56% in 2022 compared to the previous year. Interestingly, this surge in audits comes at a time when the number of auditors in New York has declined by 5% due to budget constraints.

The use of AI has enabled states like New York to audit more individuals with fewer auditors. By leveraging AI technology, tax officials are able to identify the best candidates for audits, focusing on those who earn substantial incomes. Mark Klein, partner and chairman emeritus at Hodgson Russ LLP, explains that when states are seeking revenue, they are not targeting individuals who make $10,000 a year but rather those who make $10 million.

To identify potential audit targets, states are sending out hundreds of thousands of AI-generated letters. This approach can be likened to a fishing expedition, with tax authorities casting a wide net to maximize their chances of finding tax discrepancies. The letters and calls typically concentrate on two main areas: changes in tax residency and remote work.

During the COVID-19 pandemic, many wealthy individuals relocated from high-tax states like California, New York, New Jersey, and Connecticut to low-tax states such as Florida or Texas. State tax officials are now challenging these moves, claiming that they were not permanent or legitimate. To support their claims, auditors and AI programs are examining cellphone records to determine where taxpayers spent most of their time and lived.

New York, in particular, has been extremely aggressive in its approach. The state argues that if an individual is employed by a New York company and works remotely from another state, they still owe New York taxes. This is due to the state’s “convenience rules,” which maintain that if the employer is based in New York, the employee is subject to New York taxes regardless of their physical location.

In addition to changes in tax residency, state tax authorities are also scrutinizing individuals who have moved but retained their apartments and belongings in high-tax states like New York City. The argument put forth is that since these individuals did not fully move with all of their household items, they did not actually change their tax residence. However, this perspective fails to acknowledge that wealthy individuals can afford to purchase new items for their homes in their new states.

The use of AI in targeting affluent taxpayers has raised concerns among tax attorneys and accountants. Critics argue that the aggressive approach may deter high-earning individuals from residing or conducting business in states with high taxes, leading to potential economic consequences for those states.

In conclusion, state tax officials are increasingly relying on AI to identify affluent taxpayers for audits. New York, in particular, has been at the forefront of this trend, using AI-generated letters and examining cellphone records to determine residency and tax obligations. While this approach may yield additional revenue for states, it also raises questions about fairness and the potential economic impact on high-tax states.