Tax Evasion vs. Tax Avoidance

Tax Evasion vs. Tax Avoidance: Definitions and Prison Time

Tax evasion means concealing income or information from tax authorities — and it's illegal.

Tax avoidance means legally reducing your taxable income.

Tax avoidance and tax evasion are two very different things with different definitions and different consequences

What is tax evasion?

Tax evasion is the use of illegal methods of concealing income or information from the IRS or other tax authority.

The difference between tax evasion and tax avoidance largely boils down to two elements: 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,”

For example:

· Putting money in a 401(k) or deducting a charitable donation are perfectly legal methods of lowering a tax bill (tax avoidance), as long as you follow the rules.

· Concealing assets, income or information to dodge liability typically constitutes tax evasion.

Jail time and other penalties for tax evasion

An innocent mistake on your tax return doesn’t automatically turn you into a tax evader — intent is a factor.

But if you did intend to evade taxes, here’s a taste of the penalties you could face, according to the IRS:

• A felony on your record

• Five years in jail, and/or

• A fine of up to $250,000 ($500,000 for corporations)

• A bill for the cost of prosecuting you

Prison time is a real possibility for willful tax evasion, but civil penalties may be more likely. Still, civil penalties add up — they can easily double the tax originally owed.

Some examples include:

• Failure-to-file penalties

• Underpayment penalties

• Accuracy-related penalties

• Interest on penalties owed

Another consequence of tax evasion is higher audit risk. Typically, only the last three years of your tax returns are eligible for audit. “If you omit 25% or more of your gross income [from a tax return], that extends the statute of limitations to six years,”

Think you won’t be caught?

Don’t be so sure. The IRS pays whistleblowers.

https://www.irs.gov/compliance/whistleblower-informant-award

Examples of tax evasion

Tax evasion doesn’t require elaborate schemes or dark-alley meetings. Here are a few examples of how it can happen more easily than you’d think.

1. Paying the nanny under the table

Paying someone who works for you in cash doesn’t constitute tax evasion. What does, however, is a lack of communication with the IRS and payroll tax payments. You should report the wages you pay on Schedule H and give the worker a W-2 each year. Not sure if that household helper counts as an employee? IRS Publication 926 will help you decide.

2. Ignoring overseas income

This often affects people who work or own rental properties outside of the country.

“We’ve heard a lot of times: ‘But my property is not in the U.S. Why in the world should I report any income on it if it’s a rental?" That’s one that always gets people. They think just because it’s out of the country, they don’t have to report it.

3. Banking on bitcoin

Using bitcoin won’t get you through any secret loopholes. So-called cryptocurrencies are a new phenomenon, but the IRS already has rules about them: Their transactions are taxable. And sometimes taxpayers overlook cryptocurrency holdings that have increased in value. They might get rid of it and not realize that that’s still income.

4. Not reporting income from an all-cash business or illegal activities

Some of the most common tax evasion cases involve people running cash businesses who pocket money from the cash register without reporting the income.

That is very, very common — and the IRS knows that’s very common. Tax evasion also happens when people don’t report income from illegal activities, such as drug dealing or prostitution. (Yes, you have to report that on your tax return.)

Examples of tax avoidance

When it comes to tax avoidance, there are plenty of ways to reduce your tax bill legally.

• Capitalize on tax-advantaged retirement accounts such as 401(k)s and individual retirement accounts are popular methods of tax avoidance.

• Learn more about the world of tax deductions and credits. You might qualify if you paid for tuition, day care, medical expenses or even sales taxes. Charitable donations may also help you.

• Your tax prep software or tax advisor can help you find legal options for tax avoidance.

What to do if you want to come clean

File an amended return using IRS Form 1040X, which lets you make changes to tax returns you’ve filed in the past.

In general, the IRS is sort of like religion... if you’re contrite, they generally won’t nail you.

However, there are certain areas that they do not compromise on.

Good luck!