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Tax avoidance vs. tax evasion: What is the difference?

If you always end up with a hefty tax bill at the end of the calendar year, you may look for ways to reduce your liability through various tactics. While not necessarily illegal, you need to be careful, as you may toe the line between tax avoidance and tax evasion.

According to NerdWallet, though tax avoidance and tax evasion sound similar, they are two entirely different activities. One activity is perfectly legal and the other is not. One comes with minimal to no consequences, while the other can result in jail time, hefty fines and other consequences. It is important that you understand the differences between the two so you do not unwittingly commit a crime.

Tax Evasion

You commit tax evasion when you use illegal tactics to conceal income or hide pertinent information from the IRS. Examples may include paying the babysitter under the table, failing to report income earned via cash businesses or illegal means, and deliberately omitting information regarding overseas income.

Tax avoidance

Tax avoidance entails trying to reduce taxable income via legal means. Examples of tax avoidance include claiming tax credits and the maximum allowable deductions, capitalizing on tax-advantage accounts such as 401(k)s and IRAs, and hiring a CPA to help you identify all ways in which you can reduce your tax bill. In other words, tax avoidance entails merely structuring your finances to minimize your amount of taxable income.

The consequences for tax evasion

Tax evasion is a serious crime that can result in a felony conviction, up to five years in jail, extensive fines and fees. Fees associated with tax evasion include accuracy-related penalties, failure-to-file penalties and underpayment penalties. The IRS may even charge you interest on all penalties it assesses.

Remedying the situation

If you suspect you committed tax evasion on past tax returns, the best thing you can do is come clean by filing a new correct version of each. The IRS does not want to spend time or money prosecuting you, so it will likely forgive you if you pay what you owe and remain honest going forward. However, there may come a point when the IRS is unwilling to compromise, in which case it would be in your best interest to seek legal help.

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