Tax Blog

Where Do You Draw the Line Between Minimizing Tax Liabilities vs. Tax Evasion?

Where Do You Draw the Line Between Minimizing Tax Liabilities vs. Tax Evasion?

Through loopholes and deductions, there are ways to pay less in taxes legally, but at what point do you cross into “tax evasion” territory? Since this can often seem like a fuzzy line for taxpayers, we asked a team or professionals to help define the difference.

Bruce Givner

Bruce Givner, Esq.

Bruce Givner is a tax lawyer with 43 years’ experience. Bruce has authored or co-authored over 110 articles, chapters, and books in professional publications. You can find him at KFBLawGroup.com.

The critical point

One critical point in minimizing tax liabilities vs. tax evasion is disclosure. If you disclose what you are doing on your tax return to the IRS, that is likely to result in a civil penalty, at worst, instead of an indictment. So, for example, if you are a landscape architect and you are receiving payments in cash, disclose those payments as part of your gross revenue. In contrast, if you figure you don’t need to report them because, after all, you can’t deduct all your expenses because some of your employees are illegal immigrants (so not reporting the cash offsets of what you are not able to deduct), that is tax evasion. If the IRS finds you, they are likely to want to send you to jail.

Another critical point is the pattern. You might slightly overstate your expenses in one year. For example, perhaps you took your spouse out to dinner and charged it to the business but, of course, it really wasn’t deductible under the strict rules of travel and entertainment. But if you do that 5 years in a row to the tune of $400,000 per year, that is a pattern. And the IRS just doesn’t like a pattern. Due to the amount [of money] and the fact that it is a multi-year pattern, if the IRS finds you, they are likely to want to send you to jail.

Another critical point is getting good advice. If you are uncertain of the proper reporting position, go to a competent tax lawyer or CPA. Tell that professional all the facts and follow their advice. If you do and the IRS disagrees, not only will it not be tax evasion (criminal), it is likely that you will not even be subject to a civil tax penalty.

Ben Watson

Ben Watson

Ben Watson, CPA is the virtual CFO of DollarSprout.com and founder of Fiscal Fluency, a personal finance and business coaching company. He equips small businesses and entrepreneurs with the skills and accountability to manage their businesses with confidence rather than fear.

The difference

Tax avoidance is “playing the rules to your advantage” so that you pay the least amount of taxes necessary within the confines of the law. Loopholes and claiming every allowable deduction possible are common tactics to avoiding taxes.

Tax evasion is not paying taxes despite the rules. Overstating expenses, understating income, and intentional deceit or misrepresentation to tax authorities fall under the category of “tax fraud.”

Brandon Pfaff

Brandon Pfaff

Brandon Pfaff, CPA and tax expert, serves on the advisory board for Wealthy Living Today.

Between the two

Just like most things in life, there is a ton of gray area between legal tax avoidance and tax evasion, and we see this play out in court cases all the time. To amplify the problem, tax law doesn’t provide a list of business deductions because each business has vastly different expenses. With this room for subjectivity, it leaves the door open for opinion, and this is also why tax preparers are commonly referred to as practitioners. The practitioner’s risk tolerance will determine how conservative they will be with their deductions.

With that said, I personally think the line is drawn when the taxpayers knowingly exclude income or charge deductions that are purely personal expenses. If there is a reasonable basis or clearly identifiable purpose for the expenses then the deductions should be taken. However, if you knowingly include expenses you can’t defend or don’t exist, this is intended for tax evasion.

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