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December, 2007
 
     
 

The Difference Between Tax Evasion and Tax Avoidance

On our office website, we quote Judge Learned Hand.  The quote relates to a famous tax case that every law student studying taxation becomes familiar with during law school.  Judge Hand says in the case:  Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.

What Judge Hand articulated is the thin line between tax evasion and tax avoidance.  Here is a brief explanation of the differences. 

What Is Tax Evasion?

Tax Evasion is defined in plain English as any act designed to defraud the government, i.e. more specifically, the Treasury. This definition is very broad and allows the IRS to come after you for just about any knowing misstatements on your taxes. This is a serious crime if it is not remedied appropriately.

When Must the IRS Charge You with Tax Evasion?

Generally the government has 3 years from the filing of a return or its due date, whichever occurs last, to come after you for misstatements on your taxes. But there is no time limit on when the IRS can come after you for tax evasion or for not filing.  See IRC Sec. 6501.

Punishments for Tax Evasion

Sec. 7201. of the IRC states: Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than 5 years, or both, together with the costs of prosecution.  The reference to "in addition to other penalties provided by law" alludes to numerous criminal and civil penalties, including, but not limited to, those related to fraudulent filings and failure to disclose actions.  See IRC Secs. 6011, 6663 and 7204-7207.  Numerous other civil penalties may also be imposed.  Moreover, it should be noted that tax returns are signed under the "penalty of perjury."  Perjury, as you may or may not know, is a felony, which in itself can carry significant jail time.  Conviction of tax evasion, tax fraud, perjury and any other felony can have devastating consequences, e.g. loss of the constitutional rights to vote and possess firearms, inability to qualify for bonds, employment loss, etc.

Common Types of Tax Evasion

Personal Income and Estate/Gift Tax evasion

 

  • Business Tax evasion

  • Deliberately underreporting or omitting income
  • Overstating the amount of deductions or claiming false deductions
  • Keeping two sets of books, or making false statements in books and records
  • Claiming personal expenses as business expenses
  • Hiding or transferring assets or income

 

  • Employment Tax Evasion

  • Failure to pay employment taxes
  • Falsifying payroll
  • Pyramiding
  • Employment leasing
  • Paying employees in case

There are also a number of lesser known tax evasion actions that may be imposed relating to excise taxes.

What Is Tax Avoidance?

Tax avoidance is lawfully arranging your affairs so as to minimize taxes by doing such things as deferring income from year to year or accelerating deductions in ordinary course of business. 

What Are the Available Means by which to Avoid or Minimize Taxes?

There are several ways by which you can minimize or eliminate your taxes: 

  • Income Deferral
  • Tax Deductions
  • Charitable Contributions

Income Deferral

The practice of postponing the receipt of income until after midnight on December 31st which allows the income to be taxable for the new year and need not be claimed on the current year tax returns.

Acceleration of Tax Deductions

Tax deductions are items you can deduct from the subtotal of taxes to be paid.  There are both above-the-line and below-the-line deductions which include the following: 

  • Casualty and Theft Losses
  • Charitable Contributions
  • Interest
  • Medical and Dental Expenses
  • Miscellaneous Itemized Deductions
  • Other Taxes

Charitable Contributions

You may deduct contributions to qualified charitable organizations as long as the deduction does not exceed 50% of your adjusted gross income.  Excess deductions can be carried forward to the next five taxable years.  Your adjusted gross income includes your income adjusted downward by specific deductions, but not including standard and itemized deductions.  Business owners can take advantage of certain deductions to private foundations as well; although the limitation for such deductions is generally less than those to qualified charitable organization.  Nevertheless, businesses that establish private foundations may find that such a strategy is beneficial and if done properly, yield meaningful tax avoidance results. 

What Can You Do if You Are Accused of Tax Evasion?

If you have been accused of Tax Evasion or you are facing an audit, you should speak to an experienced tax attorney or CPA immediately to learn more about your rights, your defenses in this very tricky area of tax law.

 

Conclusion

 

While the great majority of misstatements on tax returns, including those on income, payroll and estate/gift returns, are classified as civil violations under the tax code.  As such, they are subject to a myriad of civil penalties, including newly enacted penalties for preparers, which be discussed in a future newsletter.  However, in egregious situations, the IRS pursues taxpayers with a vengeance where it perceives there has been tax violations of a criminal nature, i.e. tax evasion.  The line between the two, i.e. tax evasion and tax avoidance, can become blurry at times.  Hence, it behooves most taxpayers to seek the counsel of a competent tax attorney or CPA.

 

DISCLAIMER: This Newsletter gives the reader an overview of a topic and is not intended to constitute legal advice as to any particular fact situation. In addition, laws and their interpretations change over time and the contents of this Newsletter may not reflect these changes. The reader is advised to consult competent legal counsel as to his or her particular situation.

Circular 230 Notice:  Please be advised that, based on the current IRS position, rules and standards, the tax advice contained in this Tax Newsletters  is not intended to be used, nor should it be used, for the purpose of evading any tax penalty that the IRS may legitimately assess.  That said, please do not hesitate to contact me if you have any questions regarding the matters discussed in this Tax Newsletter.  Such matters are privileged attorney-client communications.