Tax avoidance and tax evasion are very different actions; however, the line between the two can be slight. Tax avoidance is the legitimate use of federal and state tax laws and regulations to reduce one’s tax burden. On the other hand, tax evasion is illegally avoiding one’s tax responsibilities—typically, via deceit and/or concealment.
Tax Avoidance
Tax avoidance was addressed by the Supreme Court in Gregory v. Helvering, wherein the court stated that “[t]he legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.”1 Unfortunately many people pay more in taxes than they are required to, because they don’t understand the tax laws which permit them to reduce their taxes.
Examples of tax avoidance include, but are not limited to:
- Making contributions to a pre-tax retirement fund;
- Contributing money to a Health Savings Accounts;
- Deducting “ordinary and necessary” expenses to do your job; and
- Deducting charitable donations
Tax Evasion
Tax evasion, however, is the illegal avoidance of paying taxes. Significantly, Internal Revenue Code (IRC) §7201 states that:
Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.
In other words, tax evaders intend to avoid tax assessment and/or payment of taxes owed. Anyone found guilty of evading taxes can face jail time and/or significant fines.
Examples of tax evasion include, but are not limited to:
- Intentionally concealing assets to hinder the IRS’s ability to determine how much tax is owed;
- Underreporting income;
- Claiming fake business expenses;
- Claiming illegitimate dependents; and
- Not filing returns
It is also important to understand that the broad scope of the language of IRC §7201 means that anyone helping the taxpayer evade taxes, such as an accountant or bookkeeper, may be prosecuted, as well.
It’s always best to consult with a tax professional to discuss any concerns or questions about whether something is permissible avoidance or illegal evasion.
Sources:
- Gregory v. Helvering, 293 U.S. 465 (1935), at 469.