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The Difference Between Tax Avoidance and Tax Evasion

On Behalf of | Sep 13, 2018 | General Interest

Taxes are a measure instilled by the government to redistribute wealth in a manner that ensures their own coffers do not get exhausted. When they acquire taxation, which may be through direct or indirect techniques, they ideally use these funds for provisions such as public goods (roads and street lights etc.)

Tax can be an intricate subject and its comprehension is important. The aspect of tax that we will focus on is the distinction between tax avoidance and tax evasion. The difference between both is significant since exercising one is legal while the practice of the other is illegal.

We will distinguish both concepts below:

What is Tax Avoidance?

First and foremost, we will define both notions. Tax avoidance is the legitimate method of minimizing taxes, using ways included in the tax code. For instance, companies attempt to avoid incurring taxes by taking all genuine deductions and shielding their income from taxes. They orchestrate this maneuver by setting up employee retirement plans and other such endeavors.

All these aforementioned measures are legal and legitimate under the Internal Revenue Code or state taxation codes, depending on where individuals reside or where the business operates. Furthermore, we will look at examples of tax avoidance to better comprehend the concept.

Businesses typically exploit certain channels to avoid paying taxes. Some of the frequently used taxation avoidance strategies include increasing retirement savings. An individual can accomplish this by allocating money to an employer sponsored plan. A retirement fund is an effective tax avoidance tool.

Such a plan enables the individual to attribute a certain amount of their pre-tax earnings and these funds are automatically withdrawn by their employer before they receive their pay check. Other examples include maximizing work deductions. This can be done for expenses such as union dues and subscriptions. Also, using home equity and participating in a health savings account are other methods of exercising tax avoidance.

What is Tax Evasion?

On the other hand, tax evasion is an illegal practice of not paying taxes to the government. This may be done by not reporting your income properly or reporting expenses that are not legally acceptable or by not incurring taxes are owed.

Each of the aforementioned cases qualifies as tax evasion. It is frequently associated with income taxes, although the practice may be carried out by businesses on state sales taxes and employment ones as well.

Examples of tax evasion include under reporting your income. For instance, an individual may have earned extra cash through tips or doing menial tasks. If they fail to report such earnings to the government at the proper moment, they will run the risk of tax evasion. This should not transpire since tax evasion is a crime and has serious penalties attached to it as well.

Another instance of tax evasion would be to not file your tax returns at all. An individual cannot escape the authorities, in this case the IRS. The government monitors tax statements from employers and interest statements from financial institutions also. Failing to report and file your tax returns would land you in hot water ultimately.

To know more about all things related to tax law, see the Wolterman Law Office website!