Working adults, investors, business owners and others with regular sources of income must file annual income tax returns. Doing so helps reconcile estimated payments made throughout the year with the final amount actually due to the Internal Revenue Service (IRS).
Taxpayers often take advantage of credits, deductions and write-offs as a means of limiting their annual income tax liability. Most people want to minimize what they pay in taxes whenever possible. Some people may take their efforts too far and engage in illegal tax evasion.
While tax avoidance is legal, tax evasion is a crime. What separates tax avoidance from tax evasion?
Tax evasion involves inappropriate conduct
There is nothing inappropriate about using rules that exist to help people offset and limit their income tax obligations. Claiming credits and deductions based on dependent family members and writing off business or health care expenses are reasonable choices when preparing an income tax return. These tax avoidance practices are lawful. However, some people take things too far in their attempts to avoid or minimize income taxes and may commit tax evasion. The main factor that separates tax avoidance from tax evasion is fraudulent misrepresentation.
In a tax evasion scenario, a taxpayer claims credits, deductions or write-offs that they should not receive. They misrepresent the number of dependents living in their household or claim personal expenses as deductions. They may fail to report certain types of income or may exclude assets that they should disclose to the IRS. Some people are unaware that international asset reporting rules have changed. Others could make mistakes related to digital assets. They may end up underpaying their income taxes as a result.
Tax evasion is a crime
If the IRS suspects tax evasion, they may send out audit notices to taxpayers. In cases where financial reviews substantiate allegations of tax evasion, federal prosecutors may pursue criminal charges against those who misrepresented their finances while filing an income tax return. Even if prosecution isn’t an immediate risk, the taxpayer may owe past-due income taxes. The IRS can impose penalties and demand interest on the unpaid balance due.
Those facing income tax controversies may need help responding in a manner that limits their legal and financial exposure. Understanding the difference between tax evasion and tax avoidance can help people respond to audit notices or other communications sent by the IRS.