It is natural to try to minimize your tax liability. Structuring your finances to reduce your taxes is a perfectly legitimate way to manage your affairs. However, there are limits to how you can go about decreasing your taxes. Though tax avoidance and evasion sound similar, they are two terms that are viewed entirely differently by the IRS.
Tax avoidance is legal
Tax avoidance, though an intimidating term, simply refers to any legal actions that an individual may take to reduce their tax liability. This includes:
- Investing in tax-deferred accounts, such as a 401(k)
- Applying a tax credit
- Deducting business expenses
- Structuring a transaction to minimize tax owed
Tax evasion is not
Tax evasion refers to the crime of illegally underpaying your taxes. This is a felony that both individuals and corporations can commit. Common examples of tax evasion include:
- Under-reporting taxable income
- Overclaiming deductions
- Deliberately underpaying taxes
Tax evasion is a serious crime that can result in a maximum of five years imprisonment and $100,000 in fines for individuals.
Splitting the difference and the importance of intent
Tax codes are complicated. If you have a lot of assets, your finances are probably complicated as well. In both tax avoidance and tax evasion cases, individuals are trying to lower the amount of taxes that they pay. Due to the complexity of the tax code, the line between these two terms can sometimes get blurry. Using a tax attorney can help ensure that you are staying within the parameters of the law while reducing your taxes.