We want to make sure you’re on the right side of the law when it comes to filing your taxes, so in this article, we explain what tax avoidance and tax evasion are, what the difference is between the two, and a few ways you can minimize your taxes legally.
What Is Tax Avoidance?
Tax avoidance is structuring your business transactions so you can lower your tax bill. Tax avoidable is legal and wise.
A common example of tax avoidance includes maximizing your retirement contributions, such as IRAs and 401(k)s.
What Is Tax Evasion?
On the other hand, tax evasion is attempting to deceive the IRS in an effort to lower your tax bill. Tax evasion is illegal.
Common examples of tax evasion are failing to report all or some of your income, concealing business assets, or pretending personal purchases were made for business purposes.
The Difference Between Tax Avoidance and Evasion
The primary difference between tax avoidance and evasion is the intent. The intent behind tax avoidance is to only pay what taxes you legally need to pay and not a penny more. The intent behind tax evasion is to commit fraud.
How To Minimize Taxes Legally
There are three ways to minimize how much you pay in taxes:
- Reduce your taxable income – Claiming deductions can lower your taxable income. You can also hire contractors instead of employees, donate to charity, create a retirement account, and more.
- Maximize tax deductions and credits – Credits reduce your tax bill dollar-for-dollar while deductions reduce your tax bill by a percentage according to your tax bracket.
- Time income and deductions appropriately – You may change tax brackets from tax year to tax year, so timing your income and deductions accordingly can help you save money.
What if You Make a Mistake?
Mistakes happen. That’s why we offer corrections filing for 1099, 1098, W‑2, and Affordable Care Act forms.
The best course of action is to correct the mistake as soon as possible. If you make a mistake on your tax return, that will mean using Form 1040-X to file an amended return.
You can also call your tax professional to help you file the amended return and provide additional advice.
Do know that you may still be penalized (AKA need to pay a fine) for making a mistake on your tax return. This is because a mistake on your return is typically considered negligence.
Tax Evasion Penalties
According to the IRS, individuals who evade taxes may receive one or many of these penalties:
- A felony
- Five or more years in jail
- A fine of up to $250,000 ($500,000 for corporations)
- A bill for the cost of prosecuting you
- Civil penalties and their interest (more fines)
Other consequences, according to NerdWallet, include a higher risk of being audited in the future and potentially losing your tax preparer because both the IRS and your tax pro will have lost trust in you.
How to Avoid Tax Evasion Charges
To avoid potentially receiving tax evasion charges, stay on top of these things:
- Keep your bookkeeping straight and save all of your receipts – Take advantage of deductions and credits accurately. Estimating your deductions is not a good idea because it is easy to overstate them and potentially commit tax evasion.
- Pay your taxes on time – This includes estimated quarterly taxes, if applicable. This may seem obvious, but missing deadlines intentionally or accidentally can incur penalties and potentially become red flags to the IRS.
- Learn about the ever-changing tax code – Knowing tax laws can help you lower your tax liability legally.
- Consult a tax professional – A tax professional can help guide you on what deductions and credits you are eligible to receive, as well as provide you with insight on how to accurately maintain your books.
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