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Tax Evasion Vs. Tax Avoidance: The Difference and Why It Matters

Although both sound like something the IRS would frown upon, tax evasion and tax avoidance are very different things. Tax avoidance refers to using legitimate methods to lower your tax liability, while tax evasion is reducing your tax liability through deception and other fraudulent actions.

While some taxpayers knowingly initiate tax evasion tactics on their own, others fall for the promise that a questionable third party can reduce their taxes owed. The IRS often catches these tax scheme promoters and sometimes finds their clients guilty of attempting to evade taxes as well.

Understanding the difference between tax avoidance and tax evasion can help keep you out of trouble with the IRS. Keep reading to learn more about the difference between tax evasion and tax avoidance and how an experienced tax attorney may be able to help clear up misunderstandings with the IRS.

Tax Avoidance Is a Legitimate Way to Reduce Tax Liability

Tax avoidance simply means taking the tax deductions, credits, and adjustments for which you are legally eligible. Most taxpayers do it, and there is nothing wrong with finding legitimate ways to maximize your tax refund or minimize your tax liability. After all, the government created these methods to help qualified taxpayers reduce their tax liability.

A tax deduction lowers your overall taxable income. When you take tax deductions, they reduce how much income you have to pay taxes on. Some common tax deductions include contributions to tax-advantaged retirement accounts (like a 401k or an IRA), health savings account contributions (HSAs), some business expenses, the mortgage tax deduction. You can also choose between an itemized deduction or taking the standard deduction.

A tax credit lowers your tax bill dollar-for-dollar. When you take tax credits, they reduce the amount of taxes that you owe. Some credits are known as “refundable,” which means they can increase your tax refund if the amount of the tax credit is greater than the remaining taxes that you owe.

There are multiple commonly used tax credits related to children and dependents (such as the child tax credit), education and student loan interest, and green energy.

Claiming tax deductions and credits is a way to avoid paying taxes that is legally and wholeheartedly supported by the IRS tax code. These tax avoidance strategies are a big reason why taxpayers choose accountants to handle the taxes for them. Part of being a tax specialist is knowing the legal methods for reducing income taxes of clients who qualify.

RELATED: Simple Tax Deductions for Small Businesses and the Self-Employed

Tax Evasion Is Illegal and Counts as Tax Fraud

When most taxpayers think of tax fraud, they think of large corporations cheating on their taxes or tax identity thieves filing fraudulent tax returns. But tax evasion is also a type of tax fraud. Tax evasion refers to intentional, illegal attempts to not pay or underpay taxes.

You may not even realize that you are evading taxes. If you have a nanny, a housekeeper, or a yard maintenance person that you pay in cash, you may be responsible for providing a W-2 to them each year for tax reporting purposes. Failing to do so could constitute tax evasion if their wages qualify as payroll tax payments.

Ignoring overseas income can be another troublesome area. No matter where in the world you earned your money, if you are a US citizen (or US Person), then Uncle Sam gets a cut. Anything you received abroad, including wages, tips, consultancy fees, alimony, capital gains, rental income, gambling winnings and more, is potentially eligible to be taxed. Even if all you have is a foreign bank account that is earning interest, you need to report the interest to the Internal Revenue Service. Failing to pay the tax owed can result in your passport being revoked.

RELATED: Can I Get a Passport if I Owe Back Taxes to the IRS? 

Examples of Tax Evasion

One of the most common methods of tax evasion is claiming deductions and credits for which you are not legally eligible. However, there are also a variety of methods, such as:

  • Establishing a fake religious organization to evade paying taxes and claim tax-deductible “donations.”
  • Fraudulently filing a tax return claiming zero income for the year, or under-reporting your income.
  • Allocating income to a relative in a lower tax bracket.
  • Claiming personal travel expenses (souvenirs, personal meals, an upgrade to first class, etc.) as business travel expenses.
  • Omitting cryptocurrency gains from your tax return.

If you’ve knowingly (or mistakenly) under-reported taxable income, you can file amended returns for previous years. If you’ve already corrected the problem, it is far less likely that the IRS will pursue you for tax fraud.

Some taxpayers can end up guilty by association when their crooked tax preparer gets arrested for tax evasion.

Tax evasion is a criminal offense. The IRS penalizes tax evasion with hefty penalties and jail time. Never claim benefits for which you do not qualify and always ensure that anyone who prepares your taxes uses honest methods for tax avoidance and reducing your taxable income.

RELATED: Is Tax Fraud Jail Time Still Sentenced?

Can I Be Found Guilty of Tax Evasion for a Mistake?

Don’t worry; the IRS distinguishes between fraud and mistakes. To charge you with tax fraud, the IRS Criminal Investigation Division must prove that you willfully committed an offense. Making a mistake on your taxes may result in fees but should not result in evasion charges.

RELATED: What Is the Difference Between Tax Fraud and Negligence?

However, if your tax preparer is the one responsible for the evasive action, you will have to prove that you were unaware of the tactics by which they were decreasing your tax liabilities. This can be difficult to do and made more complicated if your preparer told you what they were doing, but you didn’t realize the illegality of their methods.

S.H. Block Tax Services Can Help Clear Up Misunderstandings With the IRS

If you have any questions about tax avoidance and evasion, or need help dealing with the IRS, contact our tax experts today for answers. Getting in contact with the IRS to explain a misunderstanding or issue can be difficult. Our tax attorneys are intimately familiar with the tax code and can wield that knowledge to help you resolve your tax problem.

Call us today at (410) 872-8376 or complete our brief contact form to schedule a free consultation with one of our experienced tax professionals.

The content provided here is for informational purposes only and should not be construed as legal advice on any subject.