Two terms that are used interchangeably but shouldn't be are "tax avoidance" and "tax evasion." Avoidance can be legal in the right circumstances. Evasion never is.
Those who evade taxes face substantial penalties from the IRS. However, it is possible to avoid paying taxes legally.
Tax avoidance is the legal act of reducing taxes and increasing after-tax income. People "avoid" taxes by exercising lawful abatements and tax credits, as well as through employee retirement programs.
Avoiding taxes is a legitimate way to pay the lowest tax rate.
A tax loophole is a technicality in the tax code that helps someone avoid paying taxes. Before using a tax loophole, consider that tax laws are complicated. It's best to seek out professional help from a qualified tax expert.
Tax shields are another way to avoid taxes. A tax shield is a deduction that reduces one's income taxes. For example, debt interest is sometimes deductible. So, a consumer may be able to use debt interest as a tax shield by deducting it from taxable income.
Tax avoidance requires planning. These strategies help people find the lowest possible tax rate:
Tax evasion is using illegal methods to skip paying taxes. In other terms, evading taxes involves:
According to the Internal Revenue Code, any individual who has willfully engaged in an attempt or succeeded in evading taxes is guilty of a felony by law. When caught and convicted, the penalties are large — up to $250,000 for individuals or $500,000 for corporations, and possible jail time of up to five years.
Evasion is tax fraud, which is interpreted as unlawful and deliberate non-payment of taxes. Fraud is characterized as the explicit act of deceiving and misleading.
Walter Anderson's case is one of the largest tax evasion lawsuits in U.S. history. The previous telecommunications executive was indicted for concealing his earnings by using aliases, offshore bank accounts, and shell companies.
In 2006, Anderson was arrested. He eventually confessed to hiding approximately $365 million worth of income. Walter Anderson was sentenced to nine years in prison and fined $400 million.
Anderson's plea agreement contained a clerical error in the amount, and he ended up paying less than he should have.
It's not just the big fraudsters like Walter Anderson that face penalties. Even smaller instances of tax evasion can result in civil and criminal charges.
In civil cases, the government reports that the taxpayer made a mistake, calculation error, or was inattentive in preparing and filing the taxes. Civil cases may result in a fine, but they do not include prison time like in criminal cases.
A civil tax penalty usually occurs after a state or federal tax inspector notices an issue with a tax return. This can be anything from obvious mistakes to mild calculation inaccuracies or other predicaments. Civil tax cases may end in no penalty at all or may result in fines. For example, forgetting to register a return may result in a 5% penalty, based on the volume of taxes per month.
In a criminal case, the government accuses the taxpayer of using deliberate methods to avoid paying the taxes owed. Criminal cases are more severe and can lead to fines and even imprisonment.
Ways to commit tax fraud include underreporting income, exaggerating expenses, and not filing a yearly tax return. Breaking state and federal state laws may result in the following penalties:
The penalties don't stop here. Those who receive probation, for instance, may need to maintain employment and comply with a variety of other requirements. That’s why it is best to compare tax avoidance vs evasion before committing a crime.
As mentioned above, the principal difference lies between what's legal and illegal.
According to Beverly Hills, California-based tax attorney Mitch Miller "Tax avoidance is structuring your affairs so that you pay the least amount of tax due. Tax evasion is lying on your income tax form or any other form,"
For instance, placing money in a 401(k) or subtracting a beneficent donation is absolutely legitimate to decrease a tax band. On the other hand, hiding assets, income, or data to evade accountability for taxes is an illegal practice known as evasion.
Similar to avoidance, tax planning is a legal way to decrease the amount of taxes owed. Planning helps reduce taxes through deductions, credits, discounts, and exemptions.
One benefit of tax planning is saving through a retirement plan such as Individual Retirement Accounts (IRA). For example, suppose an individual's IRA is invested in a company stock paying dividends of $1,000. In that case, this person does not have to pay the dividend tax.
A fundamental characteristic of tax planning is preparing for an individual's future. An experienced tax planner may promote tax reduction plans for the short-term and long-term.
There are tax avoidance strategies possible for many Americans. Below are the key reasons why one should — or should not — employ them:
The purpose should be to reduce one's taxes legally. Evasion is considered as the act of not paying taxes that should be paid.
Tax planning and avoidance tactics need to be legal, or else it's evasion.
Proper tax planning requires the avoidance to occur before the taxes are due. In contrast, evasion starts after liability.
Using deductions and other tax tools correctly results in owing less money. On the other hand, a tax evader may receive penalties and even jail time.
While tax planning is anything but straightforward, the line between avoidance and evasion is clear to tax professionals.
Those with any doubts about their tax planning should get help from a licensed tax specialist or firm. A professional will know about tax law changes.
The IRS provides a range of tax credits and deductions that can lawfully decrease the taxes you owe. Tax deductions help reduce the volume of taxable income. Tax credits lower the tax due, and in some instances, can produce a sizable refund.
It is your right to use legal deductions and credits. Here are the steps to make that happen.
Many people don't know that tax credits mean free money. The IRS offers 17 tax credits combined in five categories for individuals to benefit from:
You can also read more on the IRS credits and deductions page for a more in-depth analysis of all the credits.
Investing is an essential tool when you are shooting for long term wealth growth. Moreover, one of the most appealing benefits of investing in stocks, mutual funds, bonds, and real estate is the tax benefits.
An investor with a capital asset for more than one year is eligible to hold a preferred tax rate of 0%, 15%, or 20% on the capital gain, depending on the income. However, if the asset is kept for less than a year prior to selling, then the capital gain is taxed at regular income rates.
Recognizing the difference between long-term and short-term capital gains is crucial for growing wealth.
Aside from generating supplementary income, a side business gives many tax benefits. Business owners can subtract certain business expenses from their taxes. An example of a deductible expense is health insurance premiums.
If the business owner runs a home office, they can apply to deduct part of their home expenses. For example, the share of utilities around the house and the internet consumed while conducting business may be deducted.
A tax refund cash advance emergency loan is more commonly known as a refund anticipation loan (RAL). This loan is made based on the amount you will receive from the federal income tax refund.
Many different types of companies offer this product. Everyone from tax preparers like H&R Block to small financial institutions may have a tax refund loan available. It is important to do a little research to make sure that you are working with a reputable company.
Tax refund loans are generally given for a couple of weeks, which is the usual amount of time it takes for the IRS to process the tax refund.
The loan received is equal to the value of the anticipated refund minus the fees or interest charges. Borrowers may receive the loan through a prepaid card, a check, or as an electronic deposit to your bank account. When the IRS processes your refund, it may be directly issued to the lender.