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Tax avoidance vs. tax evasion: What you need to know

On Behalf of | Apr 17, 2023 | Tax Law

Tax evasion and tax avoidance are terms often used interchangeably. However, they have different meanings. In a nutshell, one is illegal while the other is not.

It helps to understand the difference between them to stay on the right side of the law as an individual or business entity. Ignorance is no defense, and the IRS will not want to hear that you failed to meet your tax compliance obligations for a lack of knowledge.

The differences explained

Tax avoidance refers to the lawful methods people use to reduce their tax liability. They include using deductions, credits and other tax breaks provided by law. Tax avoidance is perfectly legal and is a common practice among many who wish to reduce their taxes.

For example, you may take a mortgage deduction, invest in an individual retirement account (IRA) and max out your contributions to reduce your tax bill. It is well within the law to do those things. Be aware of promotors of tax savings schemes that sound too good to be true and that it never hurts to ask for a second opinion.

On the other hand, tax evasion involves failing to pay or underpaying taxes through illegal means. It is an illegal deliberate attempt to shortchange the IRS or state tax authorities. This can include claiming false deductions, engaging in tax fraud, hiding income or failing to report income altogether. Tax evasion is a criminal offense and can result in severe penalties, including fines and imprisonment.

There is a thin line between tax avoidance and evasion

The difference between tax avoidance and tax evasion can sometimes be blurry. Some tax avoidance strategies may cross the line into tax evasion if they involve intentionally misleading the government or concealing income.

Therefore, it is important to make informed consultations to ensure that your tax strategies are legal and ethical. It could give your business a competitive edge and keep you out of legal trouble.