Tax avoidance vs. tax evasion: Which is illegal?

The main difference between tax avoidance and tax evasion is that tax avoidance is permissible whereas tax evasion is a serious crime. Tax avoidance is merely another term for tax reduction.

Under federal law, taxpayers are allowed to structure their finances so that they reduce their tax obligations. Regardless of whether the taxpayer is an individual or a business entity, it is lawful to organize transactions or the manner in which income is received so that any taxes owed as a result are as little as possible. Finding ways to avoid paying the maximum tax through deductions, such as donations to charity is lawful. Tax avoidance is merely the practice of modifying finances so that the government receives a reduced amount of taxes.

A common tax avoidance practice is to defer income from one year to the next. For example, assume Mary has her property on the market and receives an offer. Based on Mary’s financial situation, if she sells in 2015 she will incur more tax than if she sold it in 2016. It is permissible for Mary to accept the offer and delay receiving payment until the beginning of 2016 which means the income she receives in 2016 will be included in her 2016 income tax return.

As previously mentioned, tax evasion is a crime. Tax evasion occurs when a taxpayer intentionally makes misrepresentations on an income tax return. Common types of actions that are considered tax evasion include, claiming deductions that the taxpayer is not eligible for or failing to report the entire amount of income received by the taxpayer. Employers can also be found guilty of committing tax evasion by failing to file payroll taxes or paying employees in cash. The IRS considers the practice of paying employees in cash a serious offense as it results in lost tax revenue and reduced future social security or Medicare benefits for the employee.

Penalties

There are serious penalties associated with committing tax evasion. Taxpayers found guilty of tax evasion can be subject to imprisonment of up to five years and fines up to $250,000 ($500,000 for corporations).

It may make sense to see a tax attorney if you are charged with tax evasion.