What is the Difference Between Tax Evasion and Tax Avoidance?

It’s not against the law to want to reduce your tax liability and pay less in taxes. However, the way in which you attempt to bring down your tax bill is something that can potentially land you in serious legal troubles. There are steps you can legitimately and legally take to minimize your tax liability. But, if you fail to pay or deliberately choose to underpay your taxes then you are “evading” taxes, which is illegal. As taxpayers, it is important that we all understand the difference between tax evasion and tax avoidance. While tax avoidance is legal, tax evasion is not.

Understanding Tax Avoidance

There are a number of ways in which you can lawfully lower your taxes, especially by employing methods that are approved by the IRS and that are legal under the tax code. When you use these legal means to bring down your tax liability, you are resorting to strategies that are termed as tax avoidance. It is a fact that many citizens end up paying more in state and federal income taxes than they may need to simply because of not understanding the tax requirements well and/or the lack good book-keeping practices. The most common way to accomplish tax avoidance tactics is by claiming all allowed deductions and credits. Here are some steps to follow by which you can legitimately reduce tax liability:

  • Retirement saving: Putting money away in a retirement fund is an effective way to reduce taxes. You may choose to contribute pre-tax to an employer-sponsored plan or you might want to open an IRA account and contribute to that.
  • College savings: Some college plans work like retirement funds in that your savings are pre-tax.
  • Home equity: Home equity loans offer the advantage of tax-deductible interest. There is a cap on how much of an annual deduction you can take based on income and whether the funds are used for home improvements.
  • Health Savings Account (HSA): If your health plan has a higher deductible, a HSA might be a good idea. The money you put in a HSA is tax-deductible and can be used to pay for medical expenses that qualify. What you don’t use that year can be rolled over to the next.

What Constitutes Tax Evasion?

Tax evasion means using illegal methods to avoid paying your taxes. Here are a few examples of tax evasion:

Underreporting income: If you fail to report any income received, be it from tips or from part-time jobs, you can be found guilty of tax evasion.

False deductions: This occurs commonly when taxpayers claim expenses they did not incur or bear on their tax returns. You are required under the law to provide accurate statements of earnings and expenses.

Failure to file: Attempting to go “under the radar” so to speak and not file a tax return would be a highly ill-advised move. If you earned income, the IRS likely knows about it through payment records.

Underpaying taxes: In addition to filing your return, you are required to pay your taxes as well. Not doing so may be grounds for severe punishment as well as penalties.

Worried About Your Tax Liability?

In many instances, the line between tax avoidance and tax evasion can be difficult to comprehend and as a result, the strategies you adopt may have legal consequences.