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Tax Evasion vs. Tax Avoidance: Definitions, Types, Consequences, Penalties and Difference

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What exactly is tax evasion?

Tax evasion is a deliberate attempt to avoid tax assessment or payment. That is the technical definition of tax evasion. But what exactly does that mean? Let’s look at the definition of tax evasion and the various sorts.

Tax evasion is when you mislead on a tax return in order to decrease the amount you owe. Assume your company earns $250,000 but only reports $100,000 on your tax return. This artificially decreases your taxable income and, as a result, your tax burden.

When you engage in intentional activity to avoid paying taxes, you are evading the payment of taxes. For example, if you leave the country without paying your tax bill, you may be committing tax evasion. However, the specifics vary depending on the situation.

types of tax evasion

To acquire a better understanding of what tax evasion is, you should investigate the many methods of tax avoidance. Tax evasion is a broad phrase that can relate to a variety of behaviors. 

However, as previously said, tax evasion is classified into two types: evading tax assessment and evading tax payment.

Actual tax evasion typically entails the taxpayer, whether a person or a business, lying about their taxable income, concealing taxable assets from the IRS, or delaying paying what they genuinely owe. 

examples of tax evasion

There are two types of tax evasion. However, a wide range of behaviors might fall into both categories. 

Here are some frequent tax avoidance vs tax evasion examples:

  • Failure to report income
  • Inflating tax deductions
  • Claiming credits that you are not legally permitted to claim
  • Makeup dependents to include on your tax return
  • Transferring assets to others in order to avoid paying taxes
  • Hiding income or assets in order to lower your tax payment.
  • Having property in the name of someone else.
  • Hiding money sources
  • Destruction of tax records
  • Filing a fictitious tax return.
  • Keeping two sets of books for your company

These are just a few scenarios in which criminal tax avoidance vs tax evasion can occur. 

the consequences of tax evasion

If you did not intend to deceive the IRS by falsely reporting your income, you are unlikely to go to jail or prison for tax evasion. 

When the IRS discovers that you have not paid what you genuinely owe in taxes, you may face the following consequences:

  • Fines 
  • Interest 
  • Criminal charges 
  • Liens 
  • Jail or prison 
  • Discontinuation of Social Security benefits
  • Loss of personal property (cars, homes) 
  • Damage to your credit
  • Passport loss

Generally, it’s best to file your tax returns honestly and then focus on figuring out how to pay your taxes later. A tax evasion lawyer can assist you in locating a program that can reconcile you with the IRS. They can assist you in leveraging the most effective legal approaches in these circumstances.

the penalties for tax evasion

Tax evasion can lead to fines of up to $250,000 for individuals and $500,000 for organizations, as well as imprisonment for up to five years.

The penalties for tax evasion vary based on the severity of the offense. For example, failure to pay a minor tax liability will generally result in a lower penalty than failure to pay a substantial tax liability. 

what is tax avoidance?

The employment of lawful ways to reduce the amount of income tax payable by an individual or a business is referred to as tax avoidance. 

To achieve this, one will claim as many legal deductions and credits as possible. Another way to achieve this is to prioritize tax-advantaged investments, such as purchasing tax-free municipal bonds. 

On the other hand, tax avoidance is not the same as tax evasion, which focuses on unlawful practices such as underreporting income and falsifying deductions.

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understanding tax evasion

Tax avoidance is a legal approach that many people might employ to avoid paying taxes or, at the very least, reduce their tax liabilities. 

Millions of people and corporations employ some type of tax evasion to reduce the amount they legally and legitimately owe to the Internal Revenue Service (IRS). Tax avoidance is also referred to as a tax shelter in this context.  

Taxpayers can avoid paying taxes by taking advantage of numerous credits, deductions, exclusions, and loopholes, such as: 

  • Claiming the child tax credit
  • Investing in a retirement account and contributing the maximum   

   the amount allowed each year

  • Taking advantage of the mortgage tax deduction
  • Contributing to a health savings account (HSA)

Before becoming a part of the United States Tax Code, credits and deductions (and consequently tax evasion) must first receive approval from the United States Congress and presidential approval. Once completed, these provisions may benefit or relieve some or all taxpayers.

The Internal Revenue Code (IRC) allows for tax evasion. Legislators use the Tax Code to affect citizen behavior by providing tax credits, deductions, or exemptions. 

They implicitly subsidize critical services such as health insurance, retirement savings, and higher education. Alternatively, they may use the tax code to further national goals, such as increased energy efficiency.

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types of tax avoidance

As previously stated, taxpayers can avoid paying taxes in numerous ways. This comprises specific tax advantages, deductions, exclusions, and United States Tax Code loopholes. 

The following are only a handful of the options taxpayers can benefit from tax avoidance.

  • the standard deduction

According to the Urban-Brookings Tax Policy Center, around 90% of households will take the standard tax deduction rather than itemize their deductions. 

The standard deduction for one individual taxpayer in 2023 was $13,850 and $27,700 for married couples filing jointly. In 2024 it is increased to $29,200. 

Even the mortgage interest deduction is no longer helpful for most Americans, especially since the Tax Cuts and Jobs Act (TCJA), signed in 2017, doubled the standard deduction and restricted deductions for state and local taxes to $10,000.

However, many small business owners, freelancers, investors, and others keep every business expense receipt that may be deducted. Others rush to the IRS challenge, looking for any tax reduction or credit they can get.

  • retirement funds

Saving for retirement implies that you are most likely avoiding taxes. That is an excellent thing. Anyone who contributes significantly to an employer-sponsored retirement plan or decides to invest in an individual retirement account (IRA) avoids taxes.

If the account is a so-called classic plan, the investor receives an instant tax break equivalent to the amount they contribute each year, up to a yearly limit. 

When the money is withdrawn when the saver retires, income taxes are due. The retiree’s taxable income will likely be smaller than the tax owed. That is tax avoidance.

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  • expenses in the workplace

You can avoid taxes by taking advantage of workplace deductions. You might be able to claim some expenses on your annual tax return that your employer does not reimburse. 

These expenses are deemed necessary for you to perform your duties. Workplace expenses include personal automobile mileage, union dues, and required tools.

  • outsourcing

The United States Tax Code contains loopholes that allow firms and high-net-worth individuals (HNWIs) to shift their money to overseas tax havens. 

These places have fewer rules, more favorable tax laws, reduced financial risks, and greater confidentiality. By establishing subsidiaries or bank accounts offshore, these tax-paying firms can avoid paying higher taxes in their home nations.

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difference between tax evasion and tax avoidance

People frequently mix up tax avoidance and tax evasion. While both are techniques to avoid paying taxes, they are different. Tax evasion is entirely prohibited, although tax avoidance is ideally allowed.

Tax evasion occurs when people underreport or fail to report earned income or revenue to a taxing authority such as the IRS. If you do not record all of your income, such as tips or incentives received by your company, you are committing tax evasion. 

Tax evasion also includes claiming credits to which you are not entitled. Some people commit tax evasion by failing to file or pay their taxes, even though they have filed returns.

Tax evasion is a significant criminal violation. Entities found guilty may face fines, imprisonment, or both. 

In Conclusion

Contrary to popular belief, tax evasion is a perfectly legal strategy to avoid paying too much tax. Various techniques are available to avoid paying or reducing your tax bill. 

You can, for example, use the standard deduction to avoid paying additional taxes on your annual income. Furthermore, if you save for retirement in an IRA, the amount is deemed a tax-advantaged approach. 

However, it should not be confused with criminal tax avoidance. When in doubt, get advice on tax services for startups from financial professionals at Countick to ensure that you are following the law.

frequently asked questions

is tax evasion legal?

No. Tax avoidance is against the law. Those who are discovered dodging taxes face criminal prosecution and severe punishments. 

Under the Internal Revenue Service (IRS) tax code, individuals can face fines of up to $250,000, while corporations are subject to fines of up to $500,000. Up to five years in prison is possible.

is tax avoidance legal?

The straightforward answer is yes. Tax avoidance is a legal strategy to avoid paying taxes. For example, you can avoid paying taxes by taking advantage of tax credits, deductions, exclusions, and loopholes.

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