Depending on who you ask, some people may say that tax avoidance is either "smart business" or it's "immoral".
But, if done correctly, there's one thing it's not...
It's not illegal.
There are numerous ways that a person can decrease his or her tax liability legally:
- Claiming deductions
- Setting up a charitable trust or foundation
- More complicated and controversial methods include setting up an offshore company, trust or foundation in an offshore jurisdiction.
Tax evasion, on the other hand, is the willful act of misrepresenting financial information to avoid the tax liability. Common forms of tax evasion are understating income, wages or gains on the sale of property and/or overstating tax deductions.
What's the Difference?
To keep it simple - think of it this way:
Tax avoidance is the maneuvering to avoid the tax liability in the first place. The tax does not exist, because in a legal sense, no income, profit or gain ever existed.
Tax evasion is maneuvering to avoid the payment of a tax liability that has already been created. The tax exists because the income, profit or gain already exists. To avoid paying the tax is a criminal act.
Why Would the Government Allow Tax Avoidance?
Obviously, no government could function if all its citizens legally avoided paying taxes. While there are legal means of tax avoidance that every citizen has a right to put into practice, there are also "abusive tax avoidance strategies" that the IRS warns against openly. These include:
- Anti-Tax Law Schemes
- Abusive Home-Based Business Schemes
- Abusive Trust Schemes
- Misuse of the Disabled Access Credit
- Abusive Offshore Schemes
- Employee Plans Abusive Tax Transactions
- Exempt Organization Abusive Tax Avoidance Transactions
The IRS tows a hard line with the promotion of Illegal Tax Schemes posing as Legal Tax Avoidance Strategies. Tax Avoidance has always had its share of hucksters and scam artists who appeal to the "greed mechanism" present in some taxpayers, by selling "get out of paying tax legally" kits and seminars. Civil Injunctions are being charged against these con artists in an effort to stop these Illegal Tax Schemes.
According to the IRS, in 2003, the government filed lawsuits to shut down 35 promoters of abusive tax schemes, and federal judges enjoined 28 promoters.
Here's one example from the IRS Website:
"Roderick Prescott and his business, Trust Educational Services, of California, were barred from allegedly selling trust schemes falsely claiming that personal expenses incurred by customers can be paid through a trust in order to obtain tax benefits not available to individuals. The court found that Prescott had sold hundreds of trust documents, some for as much as $15,500. Through the bogus trusts, Prescott told purchasers to underreport their income and claim improper deductions on their tax returns, resulting in an estimated loss of $135 million in tax revenue."
If Your Name is On a List of a Tax Shelter Promoter - The IRS is Watching You
In a recent effort to cut down on abusive tax avoidance scheme, the Department of Justice is now requiring promoters of tax shelters to make their list of clients available to the IRS. If called upon, these promoters must give names as well as details of the transactions.
For abusive tax schemes, this provision has proven to be an effective means for the IRS catching not only the promoter...but also the clients.
Here's a couple stories of abusive tax avoiders who were sentenced in 2004:
- Dr. Jon C. Pensyl, a former Worthington, Ohio dentist, was sentenced to serve 30 months in prison and pay $300,000 in restitution to the IRS for his conviction on three counts of tax evasion. Evidence introduced at trial showed from 1995 through 1997, Dr. Pensyl evaded taxation on more than $750,000 in income derived from his dental practice, rental properties and other investments by concealing his assets and income through the use of trusts and by failing to file tax returns.
- Bradford G. Brown, an Athens, Georgia physician, was sentenced to serve 41 months in prison and ordered to pay a $40,000 fine. At trial, the evidence proved that Dr. Brown had failed to report more than $1.5 million in income, which monies he used to purchase a luxury car, a radio station, real estate and other personal assets.