Tax avoidance is the use of legal methods to reduce taxable income or taxes owing. Using tax deductions and allowable tax credits is a common tactic, as is investing in tax-advantaged accounts such as IRAs and 401(k). Tax evasion is an illegal activity in which you lie to the IRS or another tax authority about the amount you owe. This can falsely mean your income, intentionally inflate your deductions, fail to report all applicable business transactions, or hide money in untraceable accounts. The IRS defines tax evasion as the intentional non-payment or underpayment of taxes. Here, what some call tax avoidance is actually tax evasion. But it is quite possible to evade taxes without even knowing it. Tax evasion is punishable by imprisonment, a fine or both. Tax avoidance and tax evasion are two very different things with different definitions and different consequences. How do you know when smart planning – tax avoidance – goes too far and crosses the line to become illegal tax evasion? Often, the distinction revolves around whether actions were taken with fraudulent intent. Another consequence of tax evasion is a higher audit risk. Generally, only the last three years of your tax returns are suitable for auditing. “If you omit 25 percent or more of your gross income [from a tax return], the statute of limitations extends to six years,” Miller says.
“It`s tax evasion,” he says. “It`s very, very common — and the IRS knows it`s very common.” If you`re saving money for retirement, you`re probably engaging in tax avoidance. And that`s a good thing. Eliminating or reducing tax avoidance is at the heart of most proposals to change tax laws. The proposals, introduced over the past decade, aim to simplify the process by flattening tax rates and removing most tax avoidance provisions. Proponents of introducing a flat tax rate, for example, argue that it eliminates the need for tax avoidance strategies. (Opponents, however, call the concept a regressive flat tax.) Paying someone who works for you in cash is not tax evasion, Freyman says. What is the case, however, is a lack of communication with the IRS and payroll tax payments. You should report the wages you pay according to Schedule H and give the worker a W-2 every year, he says. Not sure if this domestic help counts as an employee? IRS Publication 926 will help you decide. A bona fide error on your tax return is not considered tax evasion. A conviction requires the Crown to prove that you acted intentionally to evade the assessment or payment of your taxes.
This crime comes with severe penalties, including: According to the IRS, tax avoidance is a measure taken to reduce taxes payable and maximize after-tax income. The IRS states that tax avoidance is legal because there are many ways to legitimately claim deductions, tax credits or other income adjustments. These ways of avoiding taxes are often referred to as tax havens. To be considered tax evasion, the non-payment must be intentional and deliberate. As part of his tax evasion plan, he asked several of his employees to collect cheques from customers payable in his name and not in the name of the company. Then he cashed those checks and didn`t deposit the money into his company`s bank account. Since this money was neither recorded in the corporation`s books nor paid into the corporation`s account, he did not include this gross income on his income tax return. He also deducted personal expenses as operating expenses and also reduced his Schedule C profit figures, thereby significantly reducing his taxes for the 2003 to 2006 taxation years.
Although they seem similar, “tax avoidance” and “tax evasion” are radically different. Tax avoidance reduces your tax bill by structuring your transactions to give you the best tax benefits. Tax evasion is perfectly legal – and extremely clever. Tax evasion does not require elaborate plans or dark meetings. Here are some examples of how this can happen more easily than you think. “Tax avoidance structures your business so that you pay the least amount of tax owing. Tax evasion is on your income tax form or another form,” says Mitch Miller, a tax attorney based in Beverly Hills, California. Understanding the difference between tax evasion and tax avoidance doesn`t have to be complicated. The following information and examples explain which activities cross the line and expose you to an audit or worse. Now that you understand the fundamental differences between these terms, you can make smart decisions about how to reduce your tax liability. There is nothing wrong with paying as little tax as the law allows. The problem arises when you cross the line of tax evasion and underpay the taxes you owe.
The tax evasion must be financially significant enough to warrant an investigation by the IRS, and it can take several years to complete a tax evasion investigation. Concealing assets, income or information to circumvent liability is usually tax evasion. Since the federal income tax system requires you to report your worldwide income, no matter where you hold it, the income would still be taxable. There is usually nothing illegitimate about moving money. What is illegal is not reporting or paying income taxes when it may become tax evasion. Tax avoidance requires advance planning. Almost all tax strategies use one (or more) of these strategies to structure transactions to achieve the lowest possible marginal tax rate: tax evasion is a crime. Any attempt to “evade or defeat” a tax is punishable by a fine of up to $250,000 ($500,000 for businesses), five years in prison or a combination of both, according to the IRS Tax Crimes Handbook. You are also responsible for covering the costs of law enforcement. Tax evasion and tax avoidance appear similar, but they are far from interchangeable. One is a legitimate strategy to reduce your tax burden, while the other could cause you serious problems with tax authorities.