eli5: Are tax evasion and avoidance the same thing, and if not, what’s the difference?
In: Economics
Evasion is not paying taxes that you legally owe. It is a crime. Avoidance is legally using the tax rules for your benefit. It is not a crime. An example of evasion would be I claim higher expenses in my business than I actually paid and faking up some paperwork so that it looked like my profits were less than they really were.
An example of avoidance would be to wait to take money out of a retirement account (that I have to pay taxes on when I withdraw from it) until after I have quit working so that I am in a lower tax bracket and pay less taxes on the money I took out of the retirement account.
Tax evasion is not paying the taxes you owe.
Tax avoidance is not creating a situation where you owe taxes in the first place.
Also tax avoidance for the wealthy is using deductions that are in gray areas or are otherwise aggressive.
It isn’t fraud because there can be an interpretation of the very complicated Code that would enable one to interpret something in that manner. This is especially true with novel theories in which the IRS hasn’t issued an “Opinion Letter’ which clarifies it so that it is no longer in a gray area.
What will happen is that the IRS and the tax payer (or more accurately his attorney/CPA) will negotiate and come to an agreement which is almost always less than if they had paid the full tax without taking the questionable deduction or using the gray area loophole
Tax avoidance isn’t just not owing taxes; it’s taking actions that reduce your tax liability. So, putting pre-tax money into a Health Savings Account (HSA) is tax avoidance – the contributions to the account, which can only be used for healthcare expenses, are all tax deductible. Anything you contribute to it is exempted from your tax liability. This makes sense if you know you have regular healthcare expenses, as it lets you cover them from the HSA without having to be taxed on what you’d be spending for your healthcare in the first place.
Tax avoidance is entirely legal, and most of the time is done specifically with exemptions, contributions and qualified spending that is designed, under the law, to reduce your tax liability. Some of them are deliberately designed for exactly this purpose (like an HSA), and some of them, while legal, kind of exist as loopholes because they’re not being used to their intended purposes, but also not being used illegally.
Tax evasion, as mentioned already, it trying to get out of taxes that you legally do owe.
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