Basically, the main difference between tax evasion and tax avoidance is the legality aspect.
What is Tax Avoidance?
Tax avoidance is an arrangement of legally exploiting the taxation system to defeat the intent of law by unfairly taking advantage of weaknesses in the taxation rules hence reducing future or current tax liabilities. It involves seeking for new tools or methods of avoiding tax payments within the limits of the law. This may be achieved by adjusting accounts in such a way that tax rules will not be violated and at the same time minimizing tax incurrence.
In the US, the IRS regulations permit eligible tax payers to claim some credits, income adjustments and some particular deductions. For example, home owners are allowed to claim interest deduction which they pay on home mortgage. Working parents can also claim some credit in relation to expenses incurred in child care. Moreover, there are other deductions allowed depending on number of family members.
The main objective of tax avoidance is in shifting or postponing or eliminating tax liability all together. This may also be achieved through investing in governmental schemes, tax credit, deductions, tax privileges and exemptions. Here, there is no breach of law or any offense made.
Other forms of tax avoidance include changing a business structure by incorporating it or converting an offshore company to a tax haven.
Even then, the tax payer has to prove that he or she qualifies for this for it to be deemed as legal. Since many people do not know how to maintain good records and they misunderstand taxation laws, they end up paying more tax than necessary.
What is Tax Evasion?
This is illegally escaping from making tax payments. Examples of tax evasion forms involve concealing income deliberately, manipulating accounts, disclosing imaginary expenditure for deductions, deeming personal expenses as business expenditure, overstating tax credit and also suppressing capital gains and profits. Consequently, the income disclosed is not the entity’s actual income earned.
The system of income tax in the U.S is based on the notion of voluntary compliance. The system dictates that the responsibility of reporting all income lies on the tax payer. It is illegal to evade tax. When people fail to report some or all of their income, this is tax evasion. Occasionally, people achieve this by failing to report all their sources of income. They can at times fail to report income earned through illegal activities like selling stolen items or from gambling. Other times they fail to report money earned from legal activities like baby- sitting, tutoring and garage sales. Such activities of making money form part of the underground economy that exists as a means of avoiding tax. After tax officials assess the tax owed by tax payers, the IRS may raise a penalty in addition to collection of back dated taxes.
Tax evasion is a crime and the person who does it is punishable by law. Other forms of tax evasion include:
- Deliberately misrepresenting material facts
- Concealing vital documents
- Maintaining incomplete records concerning transactions
- Falsifying financial statements
Main Differences between Tax Evasion and Tax Avoidance
- Tax avoidance is a plan made for purposes of reducing the tax burden without having to infringe the law. Tax evasion on the other hand is an unlawful act committed in a bid to avoid payment of tax.
- Tax avoidance entails taking advantage of the loopholes within the law. Tax evasion entails concealing of material facts deliberately.
- Tax avoidance arrangements are made before the tax liability occurs. Tax evasion arrangements are made after tax liability occurs.
- Tax avoidance is legal while tax evasion is completely illegal and is a crime punishable under the law.
- Tax avoidance results to tax postponement while tax evasion may cause penalty or imprisonment or both on the part of the assesse if he is found guilty.