Tax Avoidance vs Tax Evasion: Key Things You Need to Know

As you enter the workforce or start your own business, making more money can come with new and exciting things, but also a tax burden. Even if you are already establish in your career, you may be thinking of strategies to reduce your tax burden, but are you sure all of those strategies are legal?

Many young individuals often forget there is a difference between tax avoidance and tax evasion, making it a great topic to dive into.

What is the Difference Between Tax Avoidance and Tax Evasion?

Let’s take a look at the definition of each so you can get a basic idea of the difference.

Tax avoidance involves using legal strategies to reduce the taxes you pay while tax evasion is an illegal method of concealing income.

If you’ve ever heard of a business or individual making a tax plan, they are looking for tax avoidance strategies to either defer or reduce taxable income.

On the other hand, tax evasion is an intentional attempt to illegally misreport income or avoid paying taxes. Bottom line is that tax avoidance is legal while tax evasion is illegal.

What are Common Tax Avoidance Strategies?

As you start to make more money, you might be wondering how you can legally reduce your taxable income. Well for starters, many individuals can claim credits and deduction on their tax return.

Common deductions include education expenses and any donations to charity. Maybe you just started a family and bought a house. The good news is that you now might be eligible to take credits for certain house expenses and a child tax credit.

There are also deductions that small business owners and self-employed individuals can claim. Common deductions include qualifying business expenses, such as bank charges and supplies. These are all aspects that decrease your taxable income.

There are also planning strategies that fall under the tax avoidance category that defers the tax paid. One example would be waiting until January 1 of the next year to sell stocks that you might have a large gain on. This is not tax evasion since it is just timing your investment choices in a more favorable manner.

Small businesses have more options available to them for tax planning strategies. Common strategies include buying more qualifying assets that they can immediately expense and utilizing different methods of accounting. It might be beneficial to buy that new laptop or piece of equipment before year end to reduce your taxable income!

What are the Penalties for Tax Evasion?

Tax evasion is a criminal offence that the IRS does not take lightly. Wouldn’t you be strict about receiving money owed to you?

The IRS has a couple different categories of offences depending on the severity and dollar amount. Common offence categories include willful failure to pay taxes, failure to file a return, fraudulent filings of returns, fraudulent withholding and false claims and statements.

This is not meant to scare you, but instead make you aware of the consequences tax evasion can come with. You don’t want to have a felony offence on your record in your early career.

The penalties remain high for these offences.

Failure to pay taxes can come with up to $250,000 in penalties and 5 years in prison. Failure to file a return comes with up to $500,000 in penalties and prison time. Intentional fraudulent filings can come with significant penalties and up to 20 years in jail time, making it something you don’t want to mess around with.

How Do I Know if I am Committing Tax Avoidance or Tax Evasion?

Knowing whether you are committing tax avoidance or tax evasion should not be too difficult to figure out.

If you ask yourself, is this really legal? Odds are it is not a legal method.

Rely on your ethics as well.

If you are trying to minimize your tax burden that is one thing, but if you are intentionally avoiding paying taxes you know you owe, that is a whole other ball game.

Consulting with a professional can be a big help in determining what is legal and what is illegal. They can guide you through a rough outline of legal planning strategies and help you avoid illegal practices.

Summary

Bottom line is that tax avoidance can bring up great planning strategies, but tax evasion can lead to significant penalties, which you want to avoid.

Google can be your best friend when it comes to deciphering between legal and illegal acts. Don’t be afraid to reach out to a professional for help!

Avoiding the IRS at your doorstep should be your number one priority as you enter the workforce or start your own business.