Paying taxes can be stressful, particularly if you're concerned that your tax liability will be large. Accountants and tax professionals work to help businesses and individuals minimize their tax liability. Tax minimization is distinct from tax avoidance because it is legal; tax minimization simply enables you to take advantage of the deductions and credits offered by the IRS, while tax avoidance occurs when you don't pay the taxes you owe. Incorrect tax minimization strategies can result in illegal tax avoidance, which is a crime.
Abusive tax avoidance commonly occurs when people don't report all of their income. For example, an independent contractor does not report the money she's paid in cash or money from some of her clients. An employee fails to report outside income, winnings from gambling or contests or bonuses paid in cash. You must report all of your income, even if you don't receive a W-2 or 1099 at the end of the tax year. Failure to report all of your income is a form of tax avoidance.
Whether engaging in tax minimization or tax avoidance, people adopting aggressive tax strategies typically claim multiple deductions. Legal tax avoidance occurs when deductions are properly claimed and you keep track of every potential deduction throughout the year. Tax avoidance, however, occurs when you claim deductions that you are not eligible for, when you claim to have spent more on a deduction-eligible item than you did or when you claim a credit you're not eligible for -- such as a credit for a child you do not have.
Both tax avoidance and tax minimization can subject you to an audit. The IRS sometimes flags people with lots of deductions, so it's important to keep records of every deduction and credit you've claimed on your income tax return. If you can't document your taxable income-reducing deductions, the IRS may label your tax practices as tax avoidance even if you really did spend the money you claim to have spent.
Tax Avoidance Penalties
The penalties for tax evasion can be stiff. If you don't file a return at all, you can be subject to a $25,000 fine per year; if the IRS can prove you willfully avoided filing a return to avoid taxation, the fine can increase to $100,000 and five years in prison. If you simply underpaid due to negligence or a misunderstanding of the tax code, you're more likely to be slapped with late fees and penalties than prison time and fines, including 5 perfect in late fees for each month you owe additional taxes, plus any interest you owe on the unpaid taxes.
Van Thompson is an attorney and writer. A former martial arts instructor, he holds bachelor's degrees in music and computer science from Westchester University, and a juris doctor from Georgia State University. He is the recipient of numerous writing awards, including a 2009 CALI Legal Writing Award.