Example Income Tax Audit Predictor

As a demonstration of the power of this approach consider the question of whose income tax returns will be audited in the IRS. The U.S. Internal Revenue Service, like most tax authorities, cannot audit all tax returns. It must, therefore, select a portion of those returns to audit. Generally, taxing authorities like to maximize the effect of those audits, by concentrating on those returns where an audit will be most likely to increase revenue or improve compliance.

The IRS system for selecting returns is a closely guarded secret, and we do not claim to have any confidential information on their system.377 However, we constructed our own predictive model of the IRS system—using publicly available information, including the IRS's own pronouncements about the focus

374 Portions of this are available on the Mathworks Web site at: http://www.mathworks.com.

375 For example, the Fuzzy Logic for Just Plain Folks online book at: http://www.fuzzy-logic.com; and the resources at http://www.austinlinks.com/Fuzzy/ and at the Berkeley Initiative on Soft Computing, at: http://www. cs.berkeley.edu/~zadeh/.

376 A credit scoring method involves giving points for specific attributes and then adding up the points to determine whether a borrower is qualified for a certain loan. Simple scoring involves the quantification of partial and subjective information, but it misses some of the logic and probability distribution features of true fuzzy logic.

We describe a credit risk fuzzy system in "A Credit Risk Fuzzy Logic Simulation Model" on page 397.

377 One IRS statement on the subject [FS-97-5] reads:

"The IRS examines (audits) tax returns to verify that the tax reported is correct. It is not an attempt to increase the tax. Selecting a return for examination does not suggest that the tax-payer has either of its enforcement and compliance efforts, as well as statistics on the characteristics of returns that are audited.

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