Taxes can be extremely complex and confusing at times. This is why a lot of people typically rely on their trusted accountant to handle their taxes and ensure that they aren’t doing anything accidentally illegal because it does happen (more than you’d think too). Although you cannot be expected to know the entire tax code, you should understand some of the basic accounting concepts, like tax evasion (illegal) vs. tax avoidance (legal).
Tax Evasion
Tax evasion is the use of illegal methods to conceal income or information from the IRS, or any other tax authority. Tax evasion can result in a multitude of different consequences like fines, penalties, and even prison.
Tax Avoidance
Tax avoidance is the use of legal methods of reducing taxable income or total tax owed to the IRS. Claiming allowed tax deductions and tax credits are common tactics, as is investing in tax-advantaged accounts such as IRAs and 401(k)s, among others.
The tax system can be extremely complex, and difficult to understand. Our CPAs have extensive knowledge and experience to know the small intricacies that can save you big time, all while staying tax compliant.
What’s The Difference
The main difference between the two ultimately comes down to two defining factors, which are: lying and hiding. “Tax avoidance is structuring your affairs so that you pay the least amount of tax due. Tax evasion is lying on your income tax form or any other form,” says, California-based tax attorney Mitch Miller.
For example, putting money in a 401(k) or deducting a donation to charity are perfectly legal methods of lowering a tax bill, which is known as tax avoidance. However, concealing assets, income, or information to dodge liability typically means that a person is committing tax evasion.
Fines, Penalties, And Other Punishments For Tax Evasion
An innocent mistake on your return doesn’t automatically equal a punishment, first, the IRS has to deem it as an intentional act. Generally, some of the penalties for this include:
- A felony on your record
- Five years in jail, and/or
- A fine up to $250,000 for an individual ($500,000 for corporations)
- A bill for the cost of the prosecution of you
While prison time is a real possibility for tax evasion, civil penalties are usually more common. As civil penalties add up the tax owed can go up by as much as double what it originally was. Some examples of how your tax payment may increase include:
- Failure to file penalties
- Underpayment penalties
- Accuracy-related penalties
- Interest on penalties owed
Wrap Up
Knowing how to stay within the IRS’s good graces is beneficial to everyone. The IRS is notorious for finding small slip-ups or mistakes in taxpayers’ paperwork to find a reason to make them pay more money. Additionally, there is a massive amount of strategy that goes into planning your taxes to minimize your tax liability legally. Speak with your trusted CPA to reduce the amount of tax you pay.