The U.S. tax code is a federal document comprised of a collection of tax laws regulating how Americans must pay their taxes. Within these laws are provisions taxpayers can use to lower their tax burden legally. Taxpayers who attempt to reduce their tax burden using unsanctioned methods are breaking the law.
The first method illustrates tax avoidance, while the second method defines tax evasion; let’s delve into the difference between the two.
Why tax avoidance is legal
The Federal Government encourages tax avoidance and uses it to promote public behaviors. It does so through tax credits, tax deductions, or tax exemptions. For example, to reach its greenhouse gas reduction goals, the federal government may offer tax credits as an incentive for consumers to buy electric cars.
Consumers who purchase electric vehicles can claim these tax credits on their tax documents, reducing their tax burden. The taxpayer may earn more value for their purchase with the tax incentives than without.
Tax avoidance opportunities create win-win scenarios for the government and the taxpayer. However, not all forms of tax avoidance appear clean-cut. Sometimes, tax avoidance seems unethical even when it is legal.
An example of this is when a large corporation applies for tax-free grants from a government program designed to assist small struggling businesses. It looks unethical because the corporation is taking advantage of tax loopholes to benefit from tax avoidance savings intended to help small, struggling businesses.
Nevertheless, the flaw resides in the language of the law, the act remains legal.
Why tax evasion is illegal
Most forms of tax evasion arise from not disclosing accurate information to the IRS during tax reporting. Tax evasion is willful, never accidental. There is little room to commit accidental tax evasion during tax time.
When filing taxes, respondents must answer specific questions. When respondents choose not to answer truthfully to lessen their tax burden, they begin walking down the path of tax evasion.
An example of deliberate tax evasion is using two different accounting books where one provides fraudulent information solely for tax reporting. To avoid tax evasion, remember that any approach utilizing the submission of falsified information is tax evasion.
Using this rule, you can see it is possible to commit tax evasion while filing for legitimate tax avoidance savings. For example, you commit tax evasion if you file for $1000 in charitable tax deductions when in reality, you only made $25 in charitable donations.
On occasion, a tax preparer may include fraudulent information on a tax return. In these instances, the IRS holds the taxpayer responsible, not the tax preparer. To protect yourself, the IRS recommends:
- Never sign a blank tax return
- Review your return before signing it, and question anything that seems unclear.
- Do not use tax preparers who base their fees on a percentage of the size of your refund.
- Use only reputable tax professionals.
Penalties of tax evasion
Getting caught for tax evasion is easier than you might realize. The IRS incentivizes people to identify offenders by offering monetary rewards to people who report those suspected of committing tax evasion.
Tax evasion is a felony crime carrying high penalties with fines up to $250,000 for individuals and $500,000 for corporations. Penalties may include imprisonment for up to 5 years, so it is important to have a skilled tax attorney to assist you.