Federal income taxes substantially reduce how much pay people retain from their employment activities. As such, particularly when people have higher income levels, workers and business owners might utilize a variety of techniques to minimize how much income tax they must pay each year.
Technically, tax avoidance is perfectly legal. It is reasonable and appropriate for taxpayers to use deductions and credits to reduce the total amount of tax that they owe based on their income. However, some people cross the line and end up committing tax evasion when their goal is to lawfully reduce how much they pay in taxes.
What is the difference between legal tax minimization or avoidance and illegal tax evasion?
The tactics and intent are different
Tax avoidance involves the lawful use of write-offs and other beneficial tax policies to reduce the total amount that someone owes in income tax each year. People sometimes make last-minute contributions to their retirement accounts or donations to charitable causes in late December as a way of reducing their total income tax burden for the year.
Other times, people itemize their deductions and write off a large assortment of different expenses, ranging from major medical expenses and mortgage interest to energy-efficient improvements to their homes. Tax avoidance entails appropriately calculating tax liability while intentionally using legal measures to reduce the final amount of taxes owed.
Tax evasion involves intentionally trying to underpay taxes. Tax evasion therefore involves someone claiming credits or deductions that they should not receive. In some cases, people may try to write off the purchase of a jet ski as a business expense. Other times, they might try to claim credits for children who are not in their custody.
Tax evasion can also involve the failure to disclose valuable personal holdings and all sources of personal income. Someone might not report their paychecks from a part-time job or their digital holdings because they assume that there is no way to track what they earned or what they own. Any scenario involving the intentional misrepresentation of someone’s finances could lead to accusations of tax evasion.
The same is true of those who intentionally manipulate and improperly apply tax rules in an attempt to reduce what they pay in federal income taxes. Tax avoidance is legal and has no implications on someone’s legal and financial circumstances other than the reduction of their tax liability. Tax evasion is illegal and might lead to both financial and criminal penalties.
Realizing when attempts to minimize taxes could constitute tax evasion may help people better respond to accusations about their tax obligations. Taxpayers who have been accused of financial misconduct may need help reviewing the evidence against them and proving that they did not violate the law. Seeking personalized legal guidance is a great way to get started.
