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Artificial Intelligence and Machine Learning Final1
Artificial Intelligence and Machine Learning Final1
Tax Analytics
Artificial Intelligence and
Machine Learning–Level 5
By Dr. Cas Milner and Dr. Bjarne Berg
Contents
03
Introduction
04
AI and ML applications —Background
05
What role will AI play in tax?
07
What topics are good candidates for
tax AI development?
08
Applications of AI in Tax— Right Now
11
The Power of Prediction with AI in Tax
12
Tools and Techniques
18
AI is part of the Tax Function
of the Future
Introduction This paper was written for tax professionals
and tax data scientists with an interest in
machine learning and artificial intelligence.
While the term ‘analytics’ is frequently Fig 1: The Five levels of Tax Analytics
used by tax practitioners, it is a broad term,
used to describe everything from business Tax Analytics generally can be grouped into 5 different levels:
intelligence, dashboards, predictive and
prescriptive tax analytics, to more advanced
areas such as machine learning (ML), data
LEVEL 5
mining, and artificial intelligence (AI). LEVEL 4 Adaptive
LEVEL 3 Prescriptive
Learning:
Data Mining,
In our Tax Function of the Future (TFoF) LEVEL 2 Predictive
Analytics, Machine
Tax
series, we have discussed the overall LEVEL 1 Dashboards,
Analytics
Modeling
Learning &
Other AI
& Tax
differences in types of analytics done Tax Business Cockpits, Planning
& Decision
Scorecards & Automation
at each level, and in this paper we are Intelligence
Visualization
(BI)
exploring “Adaptive Learning” (level 5 Self-Service
shown to the right) in more detail. We also
provide some background and examples
to better understand the tax and technical
capabilities in this emerging field of may seem unlikely that AI robots (Bots)
tax analytics. will ever serve as human-impersonating
So, what is AI? The public perception tax accountants, it is highly likely that
seems to derive from science fiction AI applications will find a role in the tax
movie depictions of malevolent robots or function of the future – and even the near
software – in “Terminator,” “2001: A Space future – assisting tax experts in detecting
Odyssey,” “Ex Machina” and so on. As errors, classifying transactions, estimating
often is the case, reality differs from the audit risk, and proposing beneficial tax
movies, even when based on true stories. strategies within increasingly complex global
With widespread marketplace adoption of legal frameworks.
AI-enabled applications such as Apple’s Siri, In this review of what is available and what
self-driving cars, IoT devices like Rachio, is coming, we discuss recent examples
and adaptive Google Search, the contrast and suggest likely future developments.
is stark: movie fantasy robots have general- We emphasize the role of tax resources
purpose function and possess human- collaborating with data science experts to
like (often evil) characteristics, while build capabilities, and also the importance
real applications are interacting with us of improving roles of increasing data quality,
unobtrusively, seamlessly, and benevolently detecting missing support documents
to enrich our lives, to simplify repetitive and details, and reducing human errors
tasks, and to assist us with making complex in complex tax compliance and analysis/
decisions with fewer errors. reporting.
Real AI – the kind that makes life better
– has arrived in the tax function, with
many usable tax applications beginning
to emerge from both academic research
and professional service firms. While it
Tax is a complex subject, and AI is highly Fig 3: Differences in AI perspectives between business and academics
technical, so discussing the two subjects
together requires solid knowledge in both Business and research community’s views of analytics
areas. Since people with these skills are hard
to find, work in this area normally is done by Business community Research community
small, focused teams of experts.
Business utility Concept Algorithm Development
Some mundane, repetitive, and routine tasks
are being enabled by AI. These include voice Enhanced insight Adaptive Neural nets, deep
and operations learning learning/query/
recognition, ATM check amount recognition reinforcement, natural
(optical character recognition – OCR), and language processing,
speech recognition,
text spell checking, supported by underlying optical character
technologies that may be readily adapted recognition
Sophistication
Sophistication
to other arenas, such as tax systems. Other Exploring scenario Prescriptive Simulation, scenario
examples include K-1’s, categorizing and benefits analytics modeling, optimization
processing information that have different Forecast results Predictive Classification, market
formats but leveraging similar forms across analytics basket analysis, decision
trees, random forest,
tax jurisdictions, classifying data into Bayesian analysis
appropriate buckets such as for categorizing
Dashboarding and Descriptive Statistics, visualization,
images for fixed asset recognition, or meals monitoring analytics charts, cluster analysis
and entertainment expenses based on tax
rules, vendors, amount, location, and time Routine decision Reporting BI tools, self-generated
support reports, excel and
of day. add-ins
2
https://www.irs.gov/tax-professionals/tax-code-
regulations-and-official-guidance
3
https://ai100.stanford.edu/2016-report
5
“Data mining Based Tax Audit Selection: A Case Study
of a Pilot Project at the Minnesota Department of
Revenue”, K.-W. Hsu et al., in Real World Data Mining
Applications, Annals of Information Systems 17, 2015.
What Tax Problem Are You Solving, Other specific algorithms include Analysis of
and How Do You Start? Variance (ANOVA), “polynomial regression”,
“logistic regression”, and “multivariate
There exist hundreds of ML algorithms,
regression”. Many of these functions are
developed by researchers across the world.
packaged in spreadsheets. While few tax
It probably is not necessary for you to
professionals are using these algorithms,
develop your own algorithm; rather, the
they are applicable in tax in areas such as
problem is selecting the right one, consistent
ETR forecasting and predicting probability
with your goals, data, and problem. This
of events such as audit/non-audits, and
selection process is part art and part science,
significant deficiency or none. In general,
based on tax data scientists’ experience, but
these algorithms address the basic question:
some general guidelines can be used.
“if present trends continue, what will
We will now take a look at the major happen?”
categories of ML, how they are typically used
Clustering
(with examples), and how they could be
applied to the tax function. For humans, recognizing cluster patterns
is trivial. It is easy for humans to identify
Forecasting three clusters of points in Figure 5 below.
This is the simplest form of prediction and However, computers can perform the
ML. Basically, the algorithm first computes same task using precise algorithms to
a trend line, and then can extrapolate, or identify these clusters, and do it faster, with
interpolate, the trend to make a prediction higher accuracy, and on vast quantities
using new data. of transactional and detailed data. In
addition, the algorithms can work with a
Today, many tax professionals do tax large number of variables, not just two (as
provision forecasting using simple shown in the Figure), and to identify groups
techniques such basic regression, rolling according to multiple categories.
averages, exponential smoothing, and
“Same As Last Year” (SALY) approaches.
However, much better advanced tax Fig 5: Tax Clustering Example
forecasting algorithms can be used that
can detect trends within tax filing cycles
Cluster 1
(typically quarterly), annual trends (such
as underlying income, inflation, and tax
payment growth), and even monthly trends
Transfer price per Product
As with clustering, there are many kinds Fig 6: Decision Tree Example
of classification algorithms. A popular,
readily interpretable type is the decision tree
Taxable income > $400k ?
(of which there are also several variants).
For example, the probability (based on
historical results) of a future tax audit for a Audit probability N Y
Donations > $40k ?
high net-worth individual could be assessed = 5%
using a decision tree (Figure 6). Similar
Audit probability N Y
decision trees can also be developed for # of donations < 3
= 17%
organizations.
Audit probability N
The ‘leaves’ and ‘branches’ in figure 6 = 29%
represent a class along the path to a specific Y
result. In this example (totally imaginary for Audit probability
= 68%
this paper), the model predicts that high-
income taxpayers claiming a higher amount • Conditions (orange) with historical audit probabilities (gray)
• Future audit possibilities can be forecast according to conditions
of charitable contributions, concentrated in
a few charities, will have a higher likelihood
of having personal tax returns audited. Level-5 Tax Analytics: Artificial Intelligence and Machine Learning 15
• The other key component is the reasoning Data entry tasks that used to take hundreds
system – how does the system make of hours, were error prone, and needed
decisions using the rules? reconciliations now can be done in a few
– First, the system must “match” the hours with much better data quality.
question to its tax knowledge – in a
In general, in OCR two technologies are at
search through the data.
work:
Natural Language – Next, it must resolve conflicts and
ambiguities because typically several a) Recognizing the “features” present in
Processing (NLP) may
search matches will be found. the pixels of the scanned image, such
be used to interpret
as numbers, lines, decorative patterns,
complex tax laws and – Finally, it needs to deliver the answer
letters, and characters.
provide guided expert to the expert, and also update the
systems for the tax knowledge base with refinements from b) Matching a wide variety of detected
professionals the search, or correction/feedback numeric images to a library of known
from the tax expert. numeric images (such as previously
recorded checks). If a company has a
Other AI expert-support systems do not “mountain” of paper documents that
begin from rules, but rather by compiling should be digitized, OCR offers hope.
a large, searchable knowledge base of tax
information from a wide array of text and In this area, the first task is based on image
image sources. pattern recognition, or “computer vision”,
and has been the subject of decades of
An example of this is IBM Watson, which can R&D.6 Note that the checks submitted to an
be trained to answer specific questions in a ATM may have smudges, are handwritten in
specific field, such as medical diagnostics, various styles, and have a variety of formats
finance, or general trivia. This area of AI, – all of which the software must recognize
known as “Deep Query”, is undergoing in order to reduce the image to a digital
active development. Even though tax base summary identifying the currency amount of
information consists of over 75,000 pages of the check.
regulations and laws, in addition to rulings
from courts and the IRS, it is near to nothing In the second part of processing, the
when compared to the vast information on characters are matched to a large library
the Internet that some AI applications are in which historical character features have
attempting to address. So, one can hope been recorded along with known quantities.
tax queries will not be more difficult than Banks, of course, have access to large
medical diagnostics. datasets of old check images together with
known check amounts, and this data forms
Optical Character Recognition (OCR) the basis for “training” the system, using
Can a computer learn to recognize text and AI techniques. This is an important point –
numbers on a printed page? The answer, of having access to a large and known dataset is
course is “yes”, and systems can do so with a critical to successfully training the system.
very high degree of accuracy. For example, In tax, we can use these systems to digitize
bank ATM machines are now capable of tax forms, handwritten notes, images, books,
scanning checks, recognizing currency contracts, and any paper-based material.
amounts, and using the information to These documents become instantly available
complete a deposit transaction – all without for complex searches and use in other AI/ML
the customer entering any information. applications.
PwC also uses a system known as ‘Dexter’ to
optically read tens of thousands of K-1 filings 6
“W. Freeman, et al., “Guest Editorial: Machine Learning
without human data entry or interventions. for Computer Vision” (2008), International Journal of
Computer Vision, 77 (1).
10
“Data mining Based Tax Audit Selection: A Case Study
of a Pilot Project at the Minnesota Department of
Revenue”, K.-W. Hsu et al., in Real World Data Mining
Applications, Annals of Information Systems 17, 2015.