Tax Avoidance vs. Tax Evasion
Updated on December 05, 2024
Andrew Landin, an IRS Enrolled Agent and Tax Lawyer with 22 years of experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working in the UK and Australia.
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Table of Contents
Tax Avoidance vs. Tax Evasion
The main difference between the two approaches is the legality of the action taken to lower or eliminate taxes. Put simply, one approach is legal, and the other is not.
Tax Avoidance is legally reducing your tax burden through methods like deductions and credits.
Tax Evasion is illegally hiding or misrepresenting information to avoid taxes.
What is Tax Avoidance?
Tax avoidance is a legal method of reducing taxable income or tax owed by an individual or business. Taxpayers use this strategy to legitimately lower their IRS tax bill.
Common strategies include:
- Claiming deductions and credits (e.g., standard deductions, child tax credits).
- Contributing to a pre-tax retirement fund to reduce taxable income.
- Investing in tax-advantaged accounts like IRAs and 401(k)s to lower tax liability.
Examples of Tax Avoidance
Here are some frequently used tax avoidance strategies:
- Standard deduction: A portion of income that is not subject to tax, based on filing status.
- Work expenses for self-employed taxpayers: E.g. deducting mileage and home office expenses.
- Mortgage interest deduction: Loans secured by your main home often have tax-deductible interest.
- Child Tax Credit (CTC): Available for dependents under 17.
- Foreign Tax Credit (FTC): Allows planning of foreign tax payments to reduce tax liability.
What is Tax Evasion?
Tax evasion occurs when a person or entity deliberately avoids paying their true tax liability through illegal methods. This is a federal offense and punishable under the IRS tax code. Intent is crucial here, as intentional failure to pay taxes constitutes evasion.
Examples of Tax Evasion
- Common forms of tax evasion include:
- Ignoring overseas income: Often an issue with people who have investments overseas.
- Under-reporting income: Includes income from illegal activities.
- Claiming false deductions: Deducting expenses not actually incurred.
- Underpaying or failing to file taxes: Deliberate non-payment or failure to file.
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What is the Standard Deduction for 2025?
As of 2024, the updated standard deduction amounts are:
- Single or married filing separately: $15,000
- Married filing jointly: $30,000
- Heads of household: $22,500
Requirements for Tax Evasion
For an act to be considered tax evasion, these conditions generally apply:
- Knowledge of tax obligations: The taxpayer knows taxes are owed.
- Willful intent: Intentional steps are taken to evade taxes.
- Affirmative action: Deliberate actions like falsifying records or failing to file.
- Concealment: Attempts to hide income or assets.
- Substantial deficiency: Typically involves significant unpaid taxes.
Penalties for Tax Evasion
If proven, tax evasion penalties include:
- Criminal record: Up to 5 years in jail and fines up to $250,000 ($500,000 for corporations).
- Civil penalties: Double the original tax owed, plus failure-to-file penalties, underpayment penalties, accuracy-related penalties, and interest on penalties.
IRS Whistle-blower Program
The IRS may reward whistle-blowers who provide valuable information on tax evaders, with awards ranging from 15-30% of the proceeds collected.
How to Report a Tax Cheat
To report a suspected tax cheat:
- Use IRS Form 3949-A to provide details on the suspected tax evader and the violation.
- Alternatively, submit a letter to the IRS with Form 211 (for reward eligibility).
- Include specific information, such as the type of violation and available records.
