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Tax Avoidance vs. Evasion — What’s the Difference?

Supreme Court Justice Oliver Wendell Holmes, Jr. is credited with saying, “taxes are the price we pay for civilized society.” No one must pay more in taxes than necessary under the U.S. Tax Code. You can structure your financial affairs to be tax efficient — but you cannot violate the law to create a lower tax situation. Knowing the difference between tax avoidance and evasion is crucial to avoid legal penalties and unintended financial consequences.  

What is Tax Avoidance?

Tax avoidance refers to the measures taken to lessen tax liability by reducing taxable income and maximizing after-tax income. The use of tax avoidance is built into the U.S. Tax Code. For instance, the Internal Revenue Service (IRS) allows taxpayers to claim certain deductions, adjustments, exclusions, and credits to income earned. Both individual taxpayers and corporations can use a variety of strategies to lower their tax bills. 

Common tax avoidance strategies for corporations can include:

  • Accelerated depreciation
  • Net operating losses
  • Taking substantial deductions for employee stock options
  • Tax credits   

Individual taxpayers can also take advantage of tax strategies to reduce their taxable income. Contributing to a flexible spending account, putting money into a traditional Individual Retirement Account, and claiming the available tax credits are a few ways individuals can use the Tax Code to their benefit. Tax avoidance should not be confused with tax evasion — tax avoidance is legal, while tax evasion is not.

What is Tax Evasion?

Tax evasion is the failure to pay taxes or the intentional underpayment of taxes in violation of the Internal Revenue Code. Tax evasion can result in felony charges, prison time, and significant monetary fines. Some common ways taxpayers evade taxes are by failing to report all income earned, hiding money through illegal accounting schemes, ignoring offshore income, omitting cryptocurrency gains, inflating expenses, and overstating deductions. 

The maximum fine an individual can face for tax evasion is $250,000. However, a corporation can face a fine of $500,000. Tax evasion can also come with a jail sentence of five years, a bill for the cost of the criminal prosecution, and additional civil penalties.    

Does Making a Mistake on Your Tax Return Constitute Evasion?

The IRS draws a distinction between tax fraud and honest mistakes. Although making a mistake on your taxes might result in monetary fines, it will not lead to criminal prosecution — unless the evasion was a willful attempt to commit fraud. When determining whether the failure to pay taxes was an intentional act, evidence must show the defendant had the ability to pay taxes but deliberately refused to do so.

If you simply made a mistake on your taxes due to negligence, you may incur a penalty for accuracy-related errors and have to pay any associated interest charges. The best course of action to take where you underreported your income is to file an amended return. A taxpayer amends his return by filing a Form 1040-X, which lets you make any needed corrections. It’s critical to have the guidance of an experienced tax attorney in these situations to ensure your rights are protected.

Contact an Experienced New York Tax Attorney

Dealing with the IRS can be a stressful situation. If you have questions regarding tax avoidance vs. evasion, a skillful tax attorney can best advise you and help ensure you remain compliant with your tax obligations. Offering reliable representation to individual taxpayers, businesses, entrepreneurs, and corporations, Brinen & Associates represents clients for a broad scope of tax matters at both the state and federal levels. Call (212) 330-8151 or send us a message to learn more about how we can assist you.

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