Tax Evasion vs. Tax Avoidance — Difference & Examples
CS
Last updated 03/15/2024 by
Camilla SmootEdited by
Summary:
Tax Evasion vs. Tax Avoidance: Tax avoidance and tax evasion are different methods people use to lower taxes. To start with, tax avoidance is legal, while tax evasion is illegal. Tax evasion can lead to a federal charge, fines, or jail time. Tax evasion includes underreporting income, not filing tax returns, and purposely underpaying taxes. Tax avoidance is taking advantage of credits and deductions, and saving for retirement.
It’s that time of the year: tax season. We’d all love to lower our taxes, but we don’t all know how. Some may worry that finding ways to lower their taxes is illegal. But there are completely legal ways to lower your taxes. This is called tax avoidance.
You may have mixed up tax avoidance with tax evasion before. While they both work to lower income taxes, tax avoidance is legal. Tax avoidance methods are also worth knowing about, as they can make a big difference for you this tax season. Keep reading to learn more about what tax evasion and tax avoidance are, and how you can legally lower your taxes.
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Tax evasion vs. tax avoidance: what are they?
Tax evasion and tax avoidance have the same goal: to lower the amount of taxes you have to pay. But the main difference between tax avoidance and tax evasion is how this goal is accomplished. Tax avoidance uses legal methods to lower taxes. Tax evasion, however, is illegal.
Popular usage and prevalent attitudes. In popular usage, people who engage in tax evasion are said to be guilty of “cheating” on their taxes. As for tax avoidance, though it is simply financial prudence in accord with law, some condemn it as “taking advantage of tax loopholes.” The sample people often also fail to draw a clear distinction between tax avoidance and tax evasion.
Broadly speaking, failures to pay the full tax one owes can be divided into three categories: nonfiling (not filing taxes at all), underreporting (filing an inaccurate return), and under-payment (paying less than owed). Here’s a look at how common each type of failure is according to the most recent IRS data (2011–2013 tax-years data as revised in 2019):
Tax evasion
Tax evasion is when someone uses illegal methods to lower or completely avoid paying taxes. This article goes over examples of tax evasion, but some common forms are not filing a return or under-reporting income.
The consequences for tax evasion include:
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Learn more about tax evasion here.
Tax avoidance
Unlike tax evasion, tax avoidance is a legal way to reduce tax liability or the amount of taxes owed. There are many legal methods you can use to lower your taxes. We’ll go over a few of them in this article, but one of the main ways is to claim all deductions and credits available.
Examples of tax evasion
The government, and a large majority of your fellow citizens, expect everyone to pay taxes, and tax laws prohibit certain practices. Tax evasion can lead to an IRS audit, jail time, or fines. These instances are considered tax evasion:
Unsure of how to file taxes? Check out our complete guide for help understanding the ins and outs of filing taxes.
Underreporting income
Failing to report income is tax evasion, so be sure to report every source of income you’ve received. This could be from a side business or income from tips.
Purposely underpaying taxes
If you know you owe taxes and deliberately choose to underpay, that too could be tax evasion. Even if you filed the tax return, you could still get in serious trouble. If you underpaid taxes and it was an honest mistake, you should not face charges.
One way to avoid mistakenly paying less than you owe is to get professional assistance preparing your taxes. This can mean either using software created by tax professionals or consulting the professionals themselves.
Not filing tax returns
The government monitors tax statements from employers, so the IRS will know to expect your return. If you owe money, an unfiled tax return is tax evasion and could lead to an IRS audit. If you’re due a refund, failing to file your tax return could be a costly mistake.
Claiming unearned deductions
Tax laws require you to be completely honest in your tax return. If you lie about a deduction, such as a child dependent, that is tax evasion.
Tax evasion isn’t just for federal income tax. Failing to pay property taxes is another form of tax evasion. In fact, some celebrities have faced penalties for doing this.
Tax Evasion vs. Tax Avoidance — Examples of tax avoidance strategies
Tax avoidance takes time and planning. You will have to think ahead if you want to reduce your federal income tax. Here are some common tax avoidance strategies that are completely legal:
Tax deductions and credits
Deductions are a great way to reduce your taxable income. Take advantage of each deduction available. Then be sure to claim any tax credits you can.
Some common tax credits and tax deductions are:
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This is just a small portion of the options available to you. Talk to a tax expert to see if these, or any others, apply to you.
Having a professional prepare your taxes could maximize your savings. Many end up paying more income tax than necessary because they don’t understand tax laws or are not aware of deductions available to them. A tax preparer can help you avoid paying more than you need to.
Work deductions
The IRS will deduct expenses for non-reimbursed business expenses. This could include travel expenses, union dues, tools, and more.
Retirement savings
Using a 401k or individual retirement account (IRA) is a legal method of tax avoidance. These accounts can lower the taxable income and taxes owed.
Health Savings Account (HSA)
This is a great option if you have a high deductible health care plan. Money contributed to an HSA is tax-deductible and can be used to pay for medical expenses. Whatever isn’t used is rolled over into the next year.
Three celebrities who have committed tax fraud
Tax laws require everyone, no matter how popular or famous, to pay taxes. And just like anyone else, celebrities could spend time in jail if they avoid paying taxes by illegal means. Here are a few of well-known celebrities who have committed tax evasion.
Martha Stewart
Chef and television personality Martha Stewart faced tax evasion charges. It turns out the star wasn’t paying taxes on her property in New York. Stewart tried to justify her actions by saying she didn’t stay there frequently enough to pay property taxes. Cable bills proved otherwise, though, and Stewart ended up paying over $220,000 in taxes.
Wesley Snipes
Actor Wesley Snipes was indicted on 8 different counts of tax fraud when it was revealed he did not pay taxes for any of his movies between 1999 and 2004. Apparently, Snipes thought he was conducting tax avoidance when he was really committing tax evasion. Snipes spent 3 years in prison and was ordered to pay a $17 million tax bill.
Willie Nelson
In 1990, beloved country singer Willie Nelson was thrown into the spotlight for tax troubles. It turns out his accountant had been committing tax evasion and hadn’t paid Nelson’s taxes in years. Not only that, he got mixed up in a fraudulent tax shelter. The IRS ended up seizing Nelson’s assets in 1990 and billed him around $16 million for unpaid taxes. Nelson had to sell many of his personal belonging to pay off the debt and avoid jail time.
Tax Evasion vs. Tax Avoidance FAQ
What are the similarities between tax evasion and tax avoidance?
Tax avoidance and tax evasion both seek to lower the amount of federal income tax owed. But only tax avoidance is legal. Failing to report income or lying on your tax return is tax evasion and can lead to jail time or fines.
Can you go to jail for tax avoidance?
You cannot go to jail for tax avoidance. Tax avoidance is using legal methods to lower taxes without breaking tax laws. Tax evasion can lead to jail.
Key takeaways
- It is legal to avoid taxes, but tax evasion is illegal.
- Tax evasion includes underreporting income, not filing tax returns, and purposely underpaying taxes.
- Avoiding taxes is taking advantage of credits and deductions. Saving for retirement, for example, can be a good way to avoid paying taxes on your income.
- You can face time in prison or receive hefty fines for tax evasion.
Make this the year you give yourself a tax cut
There are many tax preparation software packages and firms out there to help you get the most out of your tax return. Take advantage of these options, as they could help you find tax loopholes or other ways to lower your income taxes. Check out these tax preparation firm reviews and comparisons to find the best firm for you. Or, find out some free ways to receive tax help by clicking here.
CS
Camilla has a background in journalism and business communications. She specializes in writing complex information in understandable ways. She has written on a variety of topics including money, science, personal finance, politics, and more. Her work has been published in the HuffPost, KSL.com, Deseret News, and more.
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