What is the difference between tax evasion and tax avoidance, and how will the I

Question

What is the difference between tax evasion and tax avoidance, and how will the IRS determine the difference? Does the IRS differentiate between felonies and misdemeanors? What are some examples of each? Are the use of Tax Shelters, as defined by the IRS, avoidance or evasion? If you recall from one of our earlier weeks, "aggressive" tax positions are were you can interpret the law two different ways - another is where a decision in this area of the law has never been made and you are going to test how far you can go.

Explanation / Answer

Tax evasion is the illegal evasion of taxes by individuals, corporations, and trusts. Tax evasion often entails taxpayers deliberately misrepresenting the true state of their affairs to the tax authorities to reduce their tax liability and includes dishonest tax reporting, such as declaring less income, profits or gains than the amounts actually earned, or overstating deductions.

Tax avoidance is the legal use of tax laws to reduce one's tax burden. Both tax evasion and avoidance can be viewed as forms of tax noncompliance, as they describe a range of activities that intend to subvert a state's tax system, although such classification of tax avoidance is not indisputable, given that avoidance is lawful, within self-creating systems.

Avoidance of tax is not a criminal offense. Taxpayers have the right to reduce, avoid, or minimize their taxes by legitimate means. One who avoids tax does not conceal or misrepresent, but shapes and preplans events to reduce or eliminate tax liability within the parameters of the law.

Evasion involves some affirmative act to evade or defeat a tax, or payment of tax. Examples of affirmative acts are deceit, subterfuge, camouflage, concealment, attempts to color or obscure events, or make things seem other than they are.

Common evasion schemes include:

·         Intentional understatement or omission of income;

·         Claiming fictitious or improper deductions;

·         False allocation of income;

·         Improper claims, credits, or exemptions; and/or

·         Concealment of assets.

Penalties for Income Tax Fraud

A taxpayer that willfully attempts to evade paying income taxes is subject to criminal and civil penalties. The type of fraud will determine the applicable penalty. The following are some examples of possible punishments for specific types of tax fraud:

A tax shelter is a means of minimizing one's tax liability. Tax shelters can be both legal and illegal.

The Internal Revenue Service (IRS) investment vehicles such as 401(k)s and IRAs as legal tax avoidance mechanisms.

Limited partnerships are also considered legal tax shelters. They can avoid taxes because the business -- for example mining companies --require several years and heavy capital investment before a real income is realized. Taxes are levied as soon as the company starts to make income.

While retirement plans and limited partnerships are legal, many investment vehicles are illegal. A series of tax laws have been implemented to put a stop to abusive tax shelters.

The IRS will attach a fee if one places money into an "abusive" shelter. Abusive shelters are those that "exist primarily to reduce taxes unreasonably for tax avoidance or evasion... A legitimate investment produces income or capital appreciation and involves a risk of loss proportionate to the investment."

We cannot go beyond law and have to fully abide by it. So, i can go to the limits law allows me.

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