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What is the difference between tax avoidance and tax evasion?

On Behalf of | Nov 21, 2022 | Uncategorized

Some taxpayers do not know the difference between tax avoidance and tax evasion. The Internal Revenue Service defines tax avoidance as an action taken to lessen tax liability and maximize after-tax income, while tax evasion is the failure to pay or a deliberate underpayment of taxes. Tax avoidance in legal; tax evasion is not.

 Some examples of tax avoidance

Tax avoidance can be legally done to lower personal and corporate tax liability. The credits, deductions and exclusions are used by most taxpayers. These include such as child tax credits, maxing out retirement account contributions, taking deductions for mortgage interest or workplace and education deductions. Tax avoidance is built into the Internal Revenue Code by providing these credits and deductions through normal tax filings. Some of the most common are:

  • Standard deduction for personal income tax. This deduction in 2022 was $12,950 for single filers and $25,900 for married couples filing jointly. These numbers increase in 2023 to $13,850 for singles and $27,700 for couples.
  • Workplace deductions that are not reimbursed by an employer such as the cost of using a personal vehicle, purchasing tools required for your job or paying union dues.
  • Investing in IRAs or other retirement accounts, purchasing HSAs, or in other ways “sheltering” your money.
  • Legally moving money to offshore accounts with fewer regulations, better tax laws and lower risk. This allows wealthy individuals and corporations to pay at a lower tax rate than in the U.S.

 Tax evasion

While tax avoidance can be done legally with careful planning and investing, tax evasion is a criminal act and is punishable by law. If you underreport or fail to report income, you are guilty of tax evasion. Other tax manipulations such as claiming tax credits that you are not qualified to take, not paying or filing your taxes, hiding income, or keeping two sets of books are all examples of tax evasion. 

Tax evasion can be deliberate or inadvertent. Either way, it is a serious offense and can be punishable by fines or even jail time.

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