If you want to pay less taxes, there are a number of legitimate options available to you. You can go through the channels sanctioned by the Internal Revenue Service (IRS) or your state tax code, and be completely within your rights. This is referred to as tax avoidance, and it’s perfectly legal.
Taxpayers, however, must take note of the differences between tax avoidance and tax evasion. Tax evasion is illegal and can result in serious consequences. If you want to check at a lower cost how you can pay less in taxes, check out a tax app. You can sign up for free to some of these and confirm they are the right solution for you prior to paying a cent.
Tax Avoidance vs. Tax Evasion
According to the IRS, tax avoidance is an action you can take to reduce your tax liability, and therefore increase your after-tax income. Conversely, tax evasion is the failure to pay, or the intentional underpayment of your taxes. The following paragraphs detail what you should know about each concept.
Examples of Tax Avoidance
As discussed, tax avoidance is the legal practice of using approved strategies to lower your tax burden. These methods include:
- Claiming tax deductions, including health insurance premiums and charitable donations, to reduce the amount you owe. Non-reimbursed business expenses, as well as the interest on home equity loans, can be deducted as well.
- Putting money into a retirement account such as an IRA, SEP-IRA, or 401(k) will allow you to avoid paying taxes on those funds until a later date. The idea is that when you do pay taxes on the money in a retirement account, you will be in a lower tax bracket.
- Claiming tax credits such as the Child Tax Credit or the Work Opportunity Tax Credit can lead to substantial savings. The former is meant to offset child-rearing costs, while the latter is available for employers who hire people with significant barriers to employment. Note that you must be eligible for each tax credit you claim.
Examples of Tax Evasion
Tax evasion involves the use of illegal means to underpay or avoid paying your taxes. The following methods will result in severe penalties:
- Failing to file your tax return is a form of tax evasion. The IRS keeps track of any interest you may have earned through your financial institution, and they also monitor employer tax statements. In simple terms, they know that you made money, and they will take action if you fail to file your return.
- Intentionally underpaying your taxes is unlawful. That said, if you cannot afford to pay the full amount you owe, you should contact the IRS or your state agency to come up with a payment plan. Tax officials will be more accommodating if you are transparent about your situation.
- Under-reporting your income is another form of tax evasion. Workers — including those who receive cash tips — must report all of their earnings. If you don’t report your full income, you could face serious consequences ranging from fines to incarceration.
- Claiming unearned deductions, or deductions for which you are ineligible, also counts as tax evasion. Some taxpayers are tempted to write off expenses that they did not actually incur — logging a thousand extra miles of work-related driving, for instance, or claiming recreational equipment as a business expense — but this too is considered criminal activity. When you file your tax return, you must provide honest statements regarding your earnings and business expenses.
While you will not be punished for tax avoidance, you will be penalized for deliberately evading your taxes. In addition to the possibility of incurring steep fines, court costs for your case, and a federal prison sentence, you will still be responsible for paying the full amount you owe in taxes.
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