Tax Avoidance vs. Tax Evasion

Karen Rogers for Demand Media writes: When it comes to your federal tax bill, you want to pay the least amount of tax possible. However, tax law is very complicated and there are many gray areas surrounding tax deductions and credits. Sometimes it's not clear if a particular transaction is tax avoidance or tax evasion. Federal income tax evasion earned Al Capone a private suite at Alcatraz. Capone failed to file his income tax returns and was found guilty of income tax evasion. Knowing what constitutes tax avoidance and tax evasion can mean the difference between legally lowering your tax bill or following in Capone’s footsteps.

TAX AVOIDANCE

Tax avoidance is the art of legally using the federal tax code to your advantage. You avoid paying more taxes than you have to by taking every credit and deduction you legally can on your tax return. In addition, you can avoid taxes by investing in tax-free securities such as municipal bonds. You can offset your capital gains with capital losses to lower or eliminate paying capital gain tax. You can use retirement and estate planning as additional tax avoidance strategies.

LEGAL TAX WRITE-OFFS

Tax credits let you write-off your taxes dollar for dollar. The IRS has a generous list of tax credits designed to lower your tax bill, including adoption tax credits, education tax credits, retirement savings tax credit, child tax credit, earned income tax credit, child and dependent care credit and the health coverage tax credit. An equally impressive list of tax deductions can further help you avoid taxes if you take the standard deduction, charitable contributions deduction, medical and dental expense deductions, mortgage interest deduction and property tax deduction. Using all the credits and deductions you qualify for can help you avoid paying thousands in taxes.

TYPES OF TAX EVASION

Taxpayers commit tax evasion by deliberately not reporting or misrepresenting information on their tax return to reduce their taxes illegally. Underreporting, concealing or failing to report your income is one type of tax evasion. Taking deductions you're not entitled to or overstating your deduction amount is considered tax evasion. If you claim non-existent dependents or take exemptions you are not qualified for, you've committed tax evasion. If you transfer assets to avoid paying capital gains tax or conceal or destroy records, substantially underpay or fail to pay your taxes, you have committed tax evasion.

TAX EVASION PENALTIES

To get a conviction for tax evasion, the IRS must prove you owed federal taxes, that your actions indicate you evaded paying your taxes and that you knew you were responsible for paying your taxes. If you're found guilty of tax evasion, the maximum penalty is serving up to five years in federal prison and a $100,000 fine. You're also still responsible for paying your unpaid taxes and the related penalties and interest.