Tax Evasion Vs. Tax Avoidance: What’s The Difference? (2024)

While tax evasion and tax avoidance sound similar, they’re far from interchangeable. One is a legitimate strategy to reduce your tax burden, while the other could land you in serious trouble with taxing authorities. If you want to hand over less money to the IRS without the risk of going to prison, start by understanding what the two terms mean.

What Is Tax Avoidance?

Tax avoidance uses lawful methods found in the tax code to cut your total tax liability. At its core, it requires deliberately structuring your assets in such a way that you pay as little tax as possible.

Here are some examples of tax avoidance strategies:

• Maximizing your retirement contributions. Tax-advantaged retirement accounts, including IRAs and 401(k)s, allow you to reduce your taxable income as you put aside money for your later years.
• Claiming as many tax deductions as you can. Tax deductions allow you to use qualified expenses to reduce your taxable income. Some popular deductions allow taxpayers to write off gifts to charity, medical expenses, mortgage interest and some student loan interest.
• Taking tax credits to the max. Tax credits are dollar-for-dollar reductions in the amount of tax you owe, provided you meet specified qualifications. Some of the most common credits shrink your tax bill if you have children, pay for day care, buy an electric car or pay college tuition.
• Working with a tax professional. A tax pro can help ensure you legally lower your tax liability as much as possible.

What Is Tax Evasion?

Tax evasion is an illegal activity that involves lying to the IRS or another taxing authority about the amount you owe. It can involve misrepresenting your income, purposefully inflating your deductions, not reporting all applicable business transactions or hiding money in untraceable accounts.

Tax evasion is a felony. Any attempt to “evade or defeat” a tax is punishable by up to $250,000 in fines ($500,000 for corporations), five years in prison or a combination of the two, according to the IRS Tax Crimes Handbook. Plus, you’ll also be responsible for covering the costs of prosecution.

Examples of Tax Evasion

Some common examples of tax evasion include:

• Paying household employees under the table. If you’re going to pay a household employee, like a nanny or a cleaner, that money needs to be reported on a W-2 form.
• Reporting personal expenses as business expenses. While certain business expenses are tax-deductible, personal expenses are not.
• Underreporting cash transactions. If you run a cash-based business, all transactions need to be reported to the appropriate tax authorities.
• Ignoring income from international sources. If you do business internationally, you still need to report that income.
• Overstating your deductions. You need to have proof, such as receipts, for all of your eligible deductions. It’s not a good idea to estimate them.

Intentional Tax Evasion vs. Tax Mistakes

With all that said, taxing authorities understand that mistakes sometimes happen when filling out a tax return. Unintentional tax mistakes are typically considered negligence rather than evasion. Tax negligence is usually resolved by paying a smaller penalty and any associated interest charges.

Still, these penalties can be steep in their own right. For example, the IRS penalty for an accuracy-related error is 20% of the total underpaid amount.

What To Do If You Make a Mistake on Your Tax Return

If you’ve made an error on your return, the best thing to do is correct it as soon as possible. Form 1040-X allows you to file an amended return and make any necessary corrections.

If you have any questions about amending your return, your best bet is get in touch with a tax professional. They’ll be able to look at the specifics of your financial situation and offer you advice. You can also call the IRS directly at (800) 829-1040.

How To Avoid Tax Evasion Charges

Filing taxes can be nerve-wracking. If you’re nervous about underrating the amount you owe and facing tax evasion charges, you can:

• Familiarize yourself with tax law. Knowledge can go a long way if you’re worried about paying taxes correctly. Taxing authorities typically provide instructions for all of their forms. You can use these guides to learn about legal ways to lower your tax liability, including any applicable deductions, credits or exemptions.
• Consult a tax pro. If you don’t want to spend time exploring the ins and outs of the tax code, consider hiring a tax professional to help you file your return.