Tax avoidance and tax evasion are very similar in their nature. Both processes are aimed at reducing the amount of taxes payable to the state, and yet there are two major differences, namely legal and ethical considerations. From the legal perspective, tax avoidance is completely innocent, while tax evasion is a crime. From an ethical perspective, aggressive tax avoidance is also frowned upon and may be considered immoral by the court of public opinion.
According to Internal Revenue Service, tax avoidance is “An action taken to lessen tax liability and maximize after-tax income.”, while tax evasion is “A failure to pay or a deliberate underpayment of taxes.” (“Understanding Taxes – Glossary”, 2017). Therefore, tax evasion might even be unintentional, but still punishable, while tax avoidance is always a deliberate action.
Tax avoidance is any lawful action taken by tax payer to reduce the amount of tax liabilities, including the use of all tax benefits, fiscal incentives, tax exemptions, tax remissions, and any other lawful optimizations. In most structural understanding, tax avoidance is the choice of the most favorable legal and organizational forms of economic activities under particular economic circumstances to prevent the emergence of excessive tax liabilities. Strictly speaking, this is borderline tax planning, which is completely legal, but is not always possible. For example, choosing a proper form of incorporation for your target business is possible only once; if you choose to introduce some other business within the same enterprise, the previously chosen form of incorporation might turn out to be not the best fit. However, numerous business decisions exist for such cases, like outsourcing or secondment, for example.
Technically speaking, tax avoidance is the ideal tax management, when a business is using all the rights it is entitled to in every single situation it faces. But we do not live in a perfect world, where all the favorable possibilities are listed in a single document available to every business or individual. Tax regulations are numerous and complex; moreover, they frequently overlap with other legal aspects of business, which are not necessarily within the sphere of knowledge of an accountant or tax consultant. Therefore, most taxpayers use only the rights they are aware of, and thus fail to get the maximum income.
Although tax avoidance is predominant in business, and big companies avoid paying hundreds billions dollars to the state, it is also possible with regard to personal expenses. For example, according to Form 3903 of the Department of the Treasury’s Internal Revenue Service you are entitled to tax deduction for the moving costs in case you are moving your household for a new principal workplace which is 50 miles away from your previous workplace and if you will work at new job for at least 39 weeks during the next year (Department of the Treasury Internal Revenue Service, 2016).
Tax evasion is somewhat different in this respect. It happens when a business or an individual decides that it or he is entitled to more benefits than are provided legally. To that end numerous ways of decreasing one’s tax expenses exist. Possibly the most well-known one is tax havens (although formally they are still legal, it is more of evasion than of avoidance). These are usually small territories with favorable fiscal regimes. Strictly speaking, there is no income taxation in tax havens; therefore, multi-billion incomes avoid getting cut by almost 40%. This results in huge losses for the state budget: according to the study by Gabriel Zucman, world’s total underpayment in taxes due to the existence of tax havens is around $190 billion annually (Zucman, 2014).
Tax evaders use loopholes in legislation, and the most efficient methods are still inaccessible for common public, obviously. But the main trend is to use the regulations in the fashion they were not designed for. For example, a charitable trust fund can accept “donations” it is not obliged to spend. The donator can get some tax deductions on the donated property, while it still remains in his possession de facto if the head of the charity is his son or any other trusted person.
However convenient, tax evasion is punishable.
There are couple different penalties for various types of tax evasion. The most mildly punished is “Willful failure to file return, supply information, or pay tax”, which is punishable by up to 1 year of imprisonment, or fine of $100,000 for individuals and $200,000 for corporations, or both (“Related Statutes and Penalties – General Fraud”, 2017).
The second least punishable tax fraud crime is actually a list of two tax evasion activities, namely “Fraud and false statements”, and “Attempts to interfere with administration of Internal Revenue laws”, both of which are punishable by up to 3 years of imprisonment, or fine of $250,000 for individuals and $500,000 for corporations, or both (“Related Statutes and Penalties – General Fraud”, 2017).
The most punishable activities are a bit more numerous and include “Attempt to evade or defeat tax”, “Willful failure to collect or pay over tax”, and “Conspiracy to commit offense or to defraud the United States”, each of which is punished by up to 5 years of imprisonment, or fine of $250,000 for individuals and $500,000 for corporations, or both (“Related Statutes and Penalties – General Fraud”, 2017).
Obviously, the person found guilty of these crimes has to compensate the cost of the prosecution and pay all the taxes due. Nonetheless, the fines for the corporations are ridiculous, especially when compared to the amount of money avoiding taxation every year. The root of the problem lies within the imperfection of regulations and can hardly be exterminated. And yet there is probability that the number of loopholes and the ease of their use will be decreased by international efforts for complete transition to electronic money. In any case, this will not happen in the coming years, so legislation is still to be improved.
- Department of the Treasury Internal Revenue Service,. (2016). Form 3903 (p. 3).
- Related Statutes and Penalties – General Fraud. (2017). Irs.gov. Retrieved 14 February 2017, from https://www.irs.gov/uac/related-statutes-and-penalties-general-fraud
- Understanding Taxes – Glossary. (2017). Apps.irs.gov. Retrieved 13 February 2017, from https://apps.irs.gov/app/understandingTaxes/student/glossary.jsp#T
- Zucman, G. (2014). Taxing across Borders: Tracking Personal Wealth and Corporate Profits. Journal Of Economic Perspectives, 28(4), 121-148. http://dx.doi.org/10.1257/jep.28.4.121