What is the Difference Between Tax Avoidance and Tax Evasion?

You Can Avoid Taxes But You Can't Evade Them (Legally)

Tax Avoidance vs. Tax Evasion
Tax Avoidance vs. Tax Evastion. Robert D. Barnes/Getty Images

What is the Difference Between Tax Avoidance and Tax Evasion?

The terms "tax avoidance" and "tax evasion" are often used interchangeably, but they are very different concepts. Basically, tax avoidance is legal, while tax evasion is not. 

What is Tax Avoidance? 

Tax avoidance is the legitimate minimizing of taxes, using methods approved by the IRS. Businesses avoid taxes by taking all legitimate deductions and by sheltering income from taxes by setting up employee retirement plans and other means, all legal and under the Internal Revenue Code or state tax codes.

Some examples of tax avoidance: 

  • Taking legitimate tax deductions to minimize business expenses and thus lower your business tax bill. 
  • Setting up a tax deferral plan such as an IRA, SEP-IRA, or 401(k) plan to delay taxes until a later date. 
  • Taking tax credits for spending money for legitimate purposes, like taking a Work Opportunity Tax Credit 

What is Tax Evasion?

Tax evasion, on the other hand, is the illegal practice of not paying taxes, by not reporting income, reporting expenses not legally allowed, or by not paying taxes owed.

Tax evasion is most commonly thought of in relation to income taxes, but tax evasion can be practiced by businesses on state sales taxes and on employment taxes. In fact, tax evasion can be practiced on all the taxes a business owes.

Tax evasion is the illegal act or practice of failing to pay taxes which are owed. In businesses, tax evasion can occur in connection with income taxes, employment taxes, sales and excise taxes, and other federal, state, and local taxes.

Examples of practices which are considered tax evasion:

It's considered tax evasion if you knowingly fail to report income. 

Under-reporting income (claiming less income than you actually received from a specific source

  • Substantially understating your taxes (by stating a tax amount on your return which is less than the amount owed for the income you reported).

    Because tax evasion is considered intentional, the IRS can bring you under criminal charges and tax evasion can result in jail time as well as substantial fines and penalties.

Here are some other tax mistakes business owners make that are considered tax evasion. 

How to Avoid Tax Evasion

While tax evasion might seem willful, you may be subject to fines and penalties from the IRS for tax strategies they consider to be illegal and which you were unaware you were practicing.

Your best strategy is to get an honest, careful tax professional to help you with your taxes. Listen to your tax preparer, keep excellent records of all income and expenses, even if you have a cash-based business. And keep reading articles from this site and others, to learn more about what constitutes tax evasion. 

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