What is the difference between tax avoidance and tax evasion

What’s the difference between tax avoidance and evasion, is tax avoidance legal and how do the schemes work?

THE publication of the Paradise Papers has raised serious questions about the tax affairs of the rich and powerful.

What’s the difference between tax avoidance and tax evasion?

The difference between tax avoidance and evasion is legality.

In businesses, tax evasion can occur in connection with income taxes, employment taxes, sales and excise taxes, and other federal, state, and local taxes.

Meanwhile, tax avoidance involves legally bending the rules of the tax system to reduce current or future tax liabilities by means not intended by parliament.

Examples of tax avoidance are: tax deductions, changing one’s business structure through incorporation, or establishing an offshore company in a tax haven.

Is tax avoidance legal?

Most tax avoidance schemes simply do not work, and those who engage in them can find they pay more than the tax they attempted to save, once HMRC has successfully challenged them.

How do tax avoidance schemes work?

The disclosure of tax avoidance schemes (DOTAS) came into force over a decade ago, which makes anyone marketing a scheme disclose it to HMRC.

HMRC then issue a scheme number, which the tax payer has to put on his or her tax return.

HMRC has updated the official guidance on tax avoidance schemes and the implications that arise if you avoid paying tax.

Look out for these warning signs highlighted by HMRC:

You can find the full guide from HMRC here.

Difference between tax avoidance and tax evasion

Definition

In legal terms, there is a big difference between tax avoidance and tax evasion. In practice, the outcome of reducing tax bill may be similar, but tax evasion could lead to penalties under the law.

Some forms of tax avoidance are considered to be morally dubious and can lead celebrities to suffer bad publicity – even if they didn’t break the law.

Examples of tax avoidance could be

Tax evasion could be

Al Capone was tried for tax evasion because his earnings from gambling and alcohol were not submitted to the taxman.

Tax avoidance and inequality

Often it is high-income earners who are most likely to take part in tax evasion or tax avoidance schemes. They have a greater income to make it worthwhile and also the income to pay tax advisers.

Tax gap

A consequence of tax evasion and tax avoidance schemes is that governments collect less tax revenue than expected leading to a shortfall in tax revenue. This is often particularly a problem for developing countries with poor tax infrastructure.

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Tejvan Pettinger studied PPE at LMH, Oxford University. Find out more

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Difference Between Tax Evasion and Tax Avoidance

October 1, 2014 Posted by Admin

Tax Evasion vs Tax Avoidance

What is Tax Avoidance?

Tax avoidance is a mechanism used by individuals and businesses in order to avoid the payment of taxes. Tax avoidance is done by complying with the rules and regulations, yet at the same time by finding any loopholes in the laws of taxation and taking advantage of such shortcomings. Tax avoiders will find a way to exploit the taxation system and laws legally in order to avoid paying or reduce the amount of taxes. Examples of tax avoidance includes tax deductions, artificial transactions created with the aim of gaining a tax advantage, changing business structures to reduce tax rates, establishing companies in countries that offer reduced tax rates also known as tax havens, etc. Even though, tax avoidance is legal, in some instances it may be seen as unethical in that the aim of tax avoidance is to find shortcomings of the tax system in order to reduce taxes paid.

What is Tax Evasion?

Tax evasion is an illegal mechanism used in order to avoid the payment of taxes. Tax evasion goes against any taxation laws set in the country and is done in an unfair manner. Tax evaders can be imprisoned for illegal activities that they undertake to avoid the payment of taxes. Tax evaders mislead authorities by concealing their financial information through practices such as window dressing accounts in order to show low taxable income figures. Tax evasion can result in large financial penalties, payment of the entire amount of taxes due and may even result in criminal prosecution.

What is the difference between Tax Evasion and Tax Avoidance?

Tax avoidance and tax evasion are both mechanisms used in order to avoid or reduce the amount paid as taxes. The main difference between tax evasion and tax avoidance lies in that tax evasion is illegal, whereas tax avoidance is a legal method used to reduce tax payments that at times can be unethical in nature. Examples of tax evasion are untrue financial reporting, window dressing of financial accounts, hiding assets and income, claiming false deduction, avoiding payment of taxes due, etc. Tax avoidance is the minimization of taxes by using loopholes in the law and other tax reducing techniques that are approved by the IRS. Since tax evasion is illegal tax evaders can be imprisoned or compelled to pay all taxes due to avoid penalties or prosecution. Tax avoidance seeks to find methods to restructure business, accounts and transactions to reap the largest tax benefits. Individuals and firms seek the help of lawyers and financial professionals to conduct tax planning activities in order to identify legal methods to minimize taxes paid.

Summary:

Tax Avoidance vs Tax Evasion

• Tax avoidance and tax evasion are both methods used by individuals and businesses to minimize or completely avoid the payment of taxes.

• Tax avoidance is done by complying with the rules and regulations, yet at the same time by finding any loopholes in the laws of taxation and taking advantage of such shortcomings.

• Tax evasion is an illegal mechanism used in order to avoid the payment of taxes. Tax evasion goes against any taxation laws set in the country and is done in an unfair manner.

• Examples of tax avoidance include tax deductions, artificial transactions created with the aim of gaining a tax advantage, changing business structures to reduce tax rates, establishing companies in countries that offer reduced tax rates also known as tax havens, etc.

• Examples of tax evasion are untrue financial reporting, window dressing of financial accounts, hiding assets and income, claiming false deduction, avoiding payment of taxes due, etc.

• The main difference between tax evasion and tax avoidance lies in that tax evasion is illegal, whereas tax avoidance is a legal method used to reduce tax payments that at times can be unethical in nature.

What Is the Difference Between Tax Avoidance and Tax Evasion?

No one likes to pay taxes. But taxes are the law. The terms «tax avoidance» and «tax evasion» are often used interchangeably, but they are very different concepts. Basically, tax avoidance is legal, while tax evasion is not.

Businesses get into trouble with the IRS when they intentionally evade taxes. But your business can avoid paying taxes, and your tax preparer can help you do that.

Tax Avoidance

Tax avoidance is the legitimate minimizing of taxes and maximize after-tax income, using methods included in the tax code. Businesses avoid taxes by taking all legitimate deductions and tax credits and by sheltering income from taxes by setting up employee retirement plans and other means, all legal and under the Internal Revenue Code or state tax codes. 

Some Examples of Tax Avoidance Strategies

Tax Loopholes and Tax Shields

A tax loophole is tax avoidance. it’s a clause in the tax laws that people creates a hole people can go through to reduce their taxes. It’s a way to avoid paying taxes, but since it’s in the tax code it’s not evasion.

Since the tax code is so complex, savvy tax experts have found ways to lower taxes for their clients without breaking the law, taking advantage of parts of the law. If you are tempted to use a tax loophole, be aware that the tax laws are complex and difficult to interpret. Getting a competent, honest tax expert can save you from going over the line to tax evasion.

Tax shields are another strategy for avoiding taxes. A tax shield is a deliberate use of tax expenses to offset taxable income. The number of tax shields has been reduced since 2018, with the Tax Cuts and Jobs Act removing or limiting many Schedule A deductions.

Some tax loopholes are deliberate on the part of lawmakers; accelerated depreciation is one example.

Tax Evasion

Tax evasion, on the other hand, is using illegal means to avoid paying taxes. Usually, tax evasion involves hiding or misrepresenting income. This might be underreporting income, inflating deductions without proof, hiding or not reporting cash transactions, or hiding money in offshore accounts. 

Tax evasion is part of an overall definition of tax fraud, which is illegal intentional non-payment of taxes. Fraud can be defined as «an act of deceiving or misrepresenting,» and that’s what someone evading taxes does — deceiving the IRS about income or expenses. The IRS Criminal Investigation unit prosecutes cases under the broad designation of «tax fraud.» 

In this situation, the phrase «ignorance of the law is no excuse» comes to mind.

Tax Evasion and Trust Fund Taxes

Tax evasion is most commonly thought of in relation to income taxes, but tax evasion can be practiced by businesses on state sales taxes and on employment taxes. One common tax evasion strategy is failing to pay turn over taxes you have collected from others to the proper federal or state agency.

These taxes are called trust fund taxes, because they are given in trust to a business, with the expectation that they will be turned over to the appropriate state or federal agency. Failing to pay employment taxes to the IRS and sales taxes to a state taxing authority and other federal, state, and local taxes can mean high fines and penalties. 

Examples of Tax Evasion/Tax Fraud Practices

In general, it’s considered tax evasion if you knowingly fail to report income or you don’t file an income tax return. Some practices considered tax evasion/tax fraud:

Employment Tax Fraud Examples

Tax evasion isn’t limited to income tax returns. Businesses that have employees may be committing tax evasion in several ways:

Intentional Tax Evasion vs. Mistakes

Sometimes taxpayers make mistakes; this is considered negligence, not intentional tax fraud. But the IRS will probably send you a notice of penalties and interest due. In the case of a mistake that results in an underpayment of taxes, for example, the IRS can still impose a penalty of 20% of the amount of underpayment, in addition to requiring repayment. 

How to Avoid Tax Evasion Charges

While tax evasion might seem willful, you may be subject to fines and penalties from the IRS for tax strategies they consider to be illegal and which you were unaware you were practicing.

Difference Between Tax Avoidance and Tax Evasion

Last updated on May 15, 2019 by Surbhi S

Every assessee wants to escape from paying taxes, which encourages them to use various means to avoid such payment. And when it’s about savings if taxes, the two most common practices that can be seen all around the world are tax avoidance and tax evasion. Tax avoidance is an exercise in which the assessee legally tries to defeat the basic intention of the law, by taking advantage of the shortcomings in the legislature.

On the contrary, tax evasion is a practice of reducing tax liability through illegal means, i.e. by suppressing income or inflating expenses or by showing lower income. In other words, Tax Avoidance is completely lawful because only those means are employed which are legal, while Tax Evasion is considered as a crime in the whole world, as it resorts to various kinds of deliberate manipulations. To learn more differences, on the given topics, read the article provided below.

Content: Tax Avoidance Vs Tax Evasion

Comparison Chart

Definition of Tax Avoidance

An arrangement made to beat the intent of the law by taking unfair advantage of the shortcomings in the tax rules is known as Tax Avoidance. It refers to finding out new methods or tools to avoid the payment of taxes which are within the limits of the law.

This can be done by adjusting the accounts in a manner that it will not violate any tax rules, as well as the tax incurrence, will also be minimised. Formerly tax avoidance is considered as lawful, but now it comes to the category of crime in some special cases.

The only purpose of tax avoidance is to postpone or shift or eliminate the tax liability. This can be done investing in government schemes and offers like the tax credit, tax privileges, deductions, exemptions, etc., which will result in the reduction in the tax liability without making any offence or breach of law.

Definition of Tax Evasion

An illegal act, made to escape from paying taxes is known as Tax Evasion. Such illegal practices can be deliberate concealment of income, manipulation in accounts, disclosure of unreal expenses for deductions, showing personal expenditure as business expenses, overstatement of tax credit or exemptions suppression of profits and capital gains, etc. This will result in the disclosure of income which is not the actual income earned by the entity.

Tax Evasion is a criminal activity for which the assessee is subject to punishment under the law. It involves acts like:

Key Differences Between Tax Avoidance and Tax Evasion

The following are the major differences between Tax Avoidance and Tax Evasion:

Conclusion

Tax Avoidance and Tax Evasion both are meant to reduce the tax liability ultimately but what makes the difference is that the former is justified in the eyes of the law as it does not make any offence or breaks any law. However, it is biased as the honest taxpayers are not fools, but they can also make arrangements for postponing unnecessary tax. If we talk about the latter, it is completely unjustified because it is fraudulent activity, because it involves the acts which are forbidden by the law and hence it is punishable.