Tax Avoidance vs. Tax Evasion: What’s the Difference? A Guide for Expats

Dealing with taxes requires being familiar with some terms that a lot of people often get wrong, like tax evasion and tax avoidance. Confusing these two can be the difference between getting a tax reduction (good) and getting penalties that cost thousands of dollars, not to mention jail time (bad).

In this article, we’ll discuss the meaning of tax avoidance and tax evasion, explain their differences, and give some examples to make things a little less confusing for everyone.

What is Tax Avoidance?

Tax avoidance is the use of legal means to reduce your tax liabilities. Lawfully permitted tax deductions, tax credits and proactive tax planning are common methods used to reduce one’s taxes.

What is Tax Evasion?

On the contrary, tax evasion is the use of illegal ways to avoid paying tax. You commit this if you willfully fail to report your income or information to the Internal Revenue Service (IRS) or other tax authorities. Concealing your assets, income, or information by not filing your tax returns to dodge liability constitutes tax evasion.

Tax Evasion vs. Tax Avoidance

The difference between tax avoidance and tax evasion boils down to the element of concealing. In tax avoidance, you structure your affairs to pay the least possible amount of tax due. In tax evasion, you hide or lie about your income and assets altogether.

While you get reduced taxes with tax avoidance, tax evasion can result in fines, penalties, imprisonment, or even higher audit risk.

Examples of Tax Avoidance

There are lawful ways to reduce your tax, and here are some of them:

1. Tax deduction

Reducing the amount of your taxable income will also decrease your tax liability logically. Here, you subtract the amount of the tax deduction from your income, making your taxable income lower. The lower your taxable income is, the lesser your tax obligation will be.

2. Tax credit

This is a dollar-for-dollar reduction in your actual tax bill. For instance, if you owe $250 in taxes but qualify for a $1,000 credit, you’ll get a check for $750.

3. Charitable donations

Tax-deductible donations are contributions of money or goods to a tax-exempt organization such as a charity. These donations reduce taxable income. Itemize your deductions when filing tax returns annually so that you can claim tax-deductible donations to charity.

4. Individual Retirement Accounts

An individual retirement account (IRA) offers valuable tax benefits to retirement savers. This is because contributions to some IRAs can be tax-deductible. Likewise, withdrawals can be tax-free.

Other forms of tax avoidance are:

• Setting up residence in a country with low income tax rates
• Putting assets in your partner’s name so that they can pay a lower rate of income tax
• Setting up a company and paying dividends instead of income to avoid national insurance payments
• Handing down your assets to your children before dying to avoid inheritance tax
• Income shifting

Examples of Tax Evasion

Deliberately failing to report your income constitutes tax evasion. Here are some other instances wherein tax evasion can happen:

1. Not reporting to the IRS your payroll tax payments

Not reporting to the IRS the wages you pay for your employees constitutes tax evasion. To avoid this, you should communicate your payroll tax payments with the IRS by ensuring they reflect on your Schedule H and furnishing your workers a W-2 each year.

2. Failing to report income from rental properties outside of the country

This often affects people who own rental properties outside of the country.

3. Failing to disclose foreign assets including foreign bank accounts and foreign entities

The Foreign Account Tax Compliance Act (FATCA) requires owners to disclose annually to the IRS foreign assets including bank accounts and foreign entities.

In reporting your foreign assets and accounts, you may need to file the FBAR and IRS Form 8938 together with your federal income tax return each year to comply with IRS requirements.

4. Not paying Bitcoin taxes

While cryptocurrencies are a relatively new form of money, the IRS already has a rule about them: they are taxable. In filing your tax return, keep in mind that Bitcoin transactions are subject to tax.

5. Not reporting income from illegal activities

Tax evasion also happens when you don’t report income from illegal activities, such as drug dealing or prostitution. The income from these should be reported to the IRS through your tax return.

Other instances that constitute tax evasion include:

• Not reporting income to the IRS or other tax authority
• Overclaiming expenses
• Understating your tax amount owed
• Declaring bankruptcy and restarting the company under a different name

How Tax Samaritan Can Help

Tax Samaritan offers tax services for expats looking for ways to reduce their taxable income through a tax deduction, tax credit, and other legal methods.

Tax Samaritan is compliant with IRS regulations and tax laws, so partnering with us can help you avoid tax evasion and have peace of mind.

Be In the Know

While they may sound the same, tax avoidance and tax evasion are two different things. Tax avoidance is lawful because you use legal methods to reduce your taxes, while tax evasion is illegal because you deliberately fail to report your income to authorities.

To learn more about how we can help you with your taxes and tax planning, check out Tax Samaritan.