Navigating the Complexities of Tax: Evasion, Avoidance, and Planning Explained

Tax Evasion Explained

Tax evasion is illegal, meaning that the law does not allow the evasion of taxes through any means whatsoever. People who evade taxes can be charged with criminal tax evasion and face the prospects of a criminal conviction and incarceration. The IRS defines tax evasion as "the willful attempt to defeat or render a useless (i.e., null or void) a tax imposed by the United States." To prove tax evasion, the government must prove that the taxpayer acted willfully and with specific intent to evade a tax, owed and due. Even if a tax return has been filed, if it fraudulently reflects a lower amount of the tax due, the taxpayer may be guilty of tax evasion. The IRS is continually looking for suspicious tax returns to identify potential tax fraud and criminal tax evasion. They have a sophisticated computer system that scans within and across years of filings and among all taxpayers. Through the use of information documents, they may also have pertinent information about taxpayers besides the data submitted on the income tax return. Many times, information that appears to be proper is flagged, for example, a business has a very low net profit but continues to enjoy a high standard of living. In those instances, the IRS may begin a criminal investigation into a business’s activities and/or its owners .
What is the difference between tax avoidance and tax evasion? Tax avoidance is legal. At its most basic level, it involves structuring or re-doing one’s financial affairs in order to take advantage of the provisions in the tax code that provide a person with the greatest tax benefit. Tax evasion involves knowledge of a tax obligation and, then, willfully and intentionally taking actions to deficit or avoid paying that tax. Tax evasion is purposeful and willful; an individual robot could be programmed to wire funds to off shore financial institutions to avoid detection of earnings. So if a return is filed and a person simply subtracts numbers in such a way to achieve a desired refund, and the return is stamped with the person’s name. That is tax avoidance; and this scenario is not considered tax evasion. On the other hand, if a person signed the return for the sole purpose of agreeing that what was in it was true. But, they well knew that the figures submitted were false and that no report was made of their true income. That is tax evasion. In this instance, an individual who signs a tax return is certifying under penalty of perjury that the information on the return is correct and true.
Common ways to evade taxes are the omitting of wages and income, inflating deductions, and declaring fictitious expenses.

Tax Avoidance Defined

Tax avoidance, while generally legal and acceptable, can vary in degrees of aggressiveness. It is different from tax evasion, which is illegal and involves deliberately misrepresenting or concealing the true state of one’s financial affairs to reduce tax liabilities. Tax avoidance uses legal methods to minimize tax liability, such as claiming qualifying deductions, using tax credits, and taking advantage of tax-planning strategies. Controversial tax avoidance can be the subject of extreme debate, forms of which may appear in the form of aggressive tax shelters that authorities strive to seek out and shut down.

Successful Methods of Tax Planning

Effective tax planning is an essential aspect of financial management for both individuals and businesses. By tailoring their tax strategies to their unique circumstances, taxpayers can reduce their tax liability while staying within the bounds of the law. Below are several popular strategies that can help to ensure that tax planning is both effective and compliant.
Maximizing Deductions and Credits
Taxpayers should familiarize themselves with the various deductions and credits available to them. Common deductions include those related to mortgage interest, charitable contributions, and medical expenses. Tax credits, such as the earned income credit or the child tax credit, can directly reduce the amount of tax that a person owes. A tax professional can help help taxpayers identify which deductions and credits they may qualify for.
Tax-Advantaged Accounts
Using tax-advantaged accounts, such as health savings accounts (HSAs), flexible spending accounts (FSAs), health reimbursement arrangements (HRAs), individual retirement accounts (IRAs), 401(k)s, and flexible health savings plan account (FSHSPA) plans, can significantly reduce tax liability. These accounts allow individuals to either save or spend money on eligible expenses while deferring or eliminating tax payments.
Timing Income and Expenses
Strategically timing the reporting of certain income and expenses can yield tax benefits. For example, if an individual expects their income to increase in the coming year, they may benefit from deferring income until the subsequent year while accelerating expenses into the current year. When appropriate, it may also make sense to accelerate or defer certain expenses, such as the purchase of a major expense, contributions to a retirement account, or prepaying property taxes in order to reduce the current year’s tax bill.
Maintaining Accurate Records
Accurate record-keeping is the cornerstone of successful tax planning. Meticulous documentation of income, expenses, and deductions allows taxpayers to substantiate claims made on their tax returns and maximize tax benefits. It is imperative to keep detailed records of all financial transactions throughout the year.
Consulting a Tax Professional
Each individual or business should review their financial situation with a qualified tax professional to determine the most effective strategies for their particular circumstances.

Evasion, Avoidance, and Planning: What is the Difference?

Tax evasion, tax avoidance, and tax planning, while synonymous in casual conversation, are not. Distinctions exist, and they are important.
I. The Meaning of Tax Evasion
Tax evasion occurs when someone or some company purposely avoids paying taxes in order to evade paying taxes. Tax evasion is illegal and can be punished with fines and/or imprisonment if a court finds it has occurred. Tax evasion is the most extreme example of tax violations and the one most likely to result in severe punishment. Tax evasion can occur in several ways. It may involve simply making statements not true. For example, someone may exaggerate business expenses. In an extreme case, tax evasion may involve a person or company hiding income or creating fictitious expenses so that the amount of taxes owed becomes much less than what they would legitimately owe. Tax evasion is not to be confused with tax avoidance, which, as described below, is legal and sometimes even encouraged by the federal government. Amending returns, filing an absent taxpayers (i.e., someone who has not filed a return in multiple years), or paying taxes is not tax evasion if a legitimate filing will pay the correct amount.
II. The Meaning of Tax Avoidance
Tax avoidance refers to the legal and responsible use of laws to lower the tax burden. It typically involves a person or company using tax activity that is approved in the law in a way that reduces its tax burden. Because tax avoidance is legal, it is not necessary to hide it. Nevertheless, careful recordkeeping is still required, as failure to disclose certain agreements can, in some cases, make an otherwise legal position unlawful. Almost everyone pays taxes using legally permitted methods, such as deducting mortgage interest or contributing to a retirement account. This is tax avoidance. Using legal deductions and credits to reduce a tax obligation is something the government encourages. For example, credits for first-time home buyers, child care, and education are enacted since they support valid public policy goals. Also, tax deductions for such things as student loan interest or tuition provide incentives to take actions the government believes support sound policy.
III. The Meaning of Tax Planning
Tax planning, like tax avoidance, is legal and encouraged by the government. Tax planning typically refers to the activities used to arrange a person’s or a company’s finances so that they are prepared to execute proper tax avoidance strategies. Tax planning may be informal or formal. It may be as simple as ensuring any invoices are sent out during a year so taxes are paid in the appropriate year. It may be as complicated as valuing securities held or purchased. Before purchasing securities, you may wish to consider the potential tax burdens to be paid should they increase. Several rules restrict the ability to carry backwards capital losses. There are significant limitations on carry forwards and offsets. Tax planning can help avoid issues.
IV. Summary
Tax evasion is illegal, and tax avoidance and planning are legal. Tax evasion involves circumventing tax laws, which can result in criminal penalties. Tax avoidance and planning use the system in a manner authorized by the law.

Analyzing Cases and Real-World Examples

Numerous high-profile cases have demonstrated the stark divide between tax evasion and tax avoidance. The most infamous is undoubtedly that of former Major League Baseball pitcher Curt Schilling, who defaulted on a $2 million tax lien after he failed to pay a state tax on his $48.5 million winnings in an online Internet video game business he owned. The state of Rhode Island’s Department of Revenue claimed it never should have approved Schilling’s loan to launch the company because the state had provided $124 million in loans and loan guarantees to the company only to see it default on those loans. Schilling filed for bankruptcy in 2015, and the state received a $2 million settlement with his corporate entity in 2018. He was left to deal with a personal judgment of $1.4 million.
A more recent case involves Robert Smith, the billionaire founder of Vista Equity Partners and the most notable private equity executive ever. In July 2020, Smith was indicted on charges of tax evasion. Smith has been accused of conspiring to conceal the true nature, source, origin and ownership of income and funds through the use of various offshore structures. While there’s still no clear picture of what the outcome of the case will be, it clearly shows the scrutiny the IRS and other federal agencies are putting on Americans with significant offshore bank accounts .
More examples of gray area tax avoidance strategies include micro-captive insurance arrangements. The Internal Revenue Service targets this strategy because the micro-captives reduce taxable net income by shifting profits from the insured companies to insurance companies that are partially controlled by the owners of the insureds. One area that can be particularly troublesome for taxpayers is valuation of such insurance arrangements. The IRS doesn’t take into account any subjective factors in its valuation assessments, and certain statistically conservative assumptions about mortality and related factors (such as assuming that all captive plans will eventually settle claims) thus can drastically impact their value. This is one area where a thorough tax plan may help the taxpayer mitigate any potential problems with the IRS.
In terms of successful tax planning, the work of famous tax attorneys like Martin Ginsburg and his wife, Supreme Court Justice Ruth Bader Ginsburg, gives a helpful picture of how families can organize their estate plans in order to reduce tax liabilities. Ways to do this include structuring family partnerships, making gifts to family partners, maintaining outside family bank records, and divesting real estate from descendants’ estates.

A Look at Tax Laws and Guidelines

Tax evasion, tax avoidance, and tax planning may seem like the same terms, but there are essential differences between them that have significant implications for enforcing the UK tax laws. The law will look at the different steps in these concepts in different ways: the law judges tax evasion and tax avoidance as unlawful, while tax planning is encouraged.
The tax laws and regulations aim to present a clear structure for taxpayers to follow. Accordingly, tax evasion is clearly a criminal offence. Tax avoiders must make sure that whatever step they take is permitted by the tax laws; in this way, tax avoiders become tax planners. As tax planners ensure that their tax liability is limited by law, this method allows the use of the tax relief rather than avoidance of tax itself. The difference between tax avoidance and tax planning is that the latter is an appropriate use or exploitation of the tax laws and encourages the honest taxpayer.
However, it has been held (in W.T. Ramsay Ltd v Inland Revenue Commissioners [1981] 1 All ER 865) that in determining what constitutes tax avoidance, the court will look at the artificiality of the transaction. In such circumstances, courts are entitled to "look at the whole picture behind the transaction and see the scheme as a composite whole and not a series of isolated steps".
UK tax laws are continually updated to develop clarity in the system. Certain steps must be taken to understand the correct tax liability. The complexity of tax laws can sometimes mean that taxpayers are not fully aware of their liabilities. People must be updated on changes to the tax laws; this may be through the specific reading of the laws and regulations, or through financial advisers, tax consultants, etc.

Helpful Tips and Techniques

The most important tip for individuals and businesses alike is to not attempt to evade taxes. Tax evasion is illegal, and can lead to criminal prosecution, penalties, and interest on any additional tax liabilities imposed following an audit. Therefore, it is a good idea to keep complete and accurate records of your financial transactions. For this reason, in addition to maintaining the necessary books and records, for individuals and businesses that own or do business through a foreign corporation, foreign trust or foreign bank account, filing an accurate and timely Form 8938, FinCEN Form 114 and FinCEN Form 114C (for foreign trusts) is absolutely imperative . The penalties can be enormous. Most importantly, if you do receive a notice of an audit from the IRS, it is a good idea to consult a tax professional and have them represent you during the audit process. Likewise, if you receive a notice of a proposed adjustment following an audit, it is important to consult a tax attorney before responding to the notice, so that you can review the proposed adjustment and adequate supporting documents can be generated, if needed. Consulting a tax professional will provide you with peace of mind and helps ensure you remain compliant with all relevant tax laws.