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Tax Avoidance vs Tax Evasion

Rich people don’t pay taxes because they invest in REALLY GOOD accountants who are skilled in tax avoidance, not to be confused with tax evasion.  In this season of politics, this type of talk is making its way through the daily headlines.  As a tax professional, I see the most confusion in knowing the difference between avoidance and evasion.  One is criminal and one is the work of a valuable accountant, which finding at H&R Block is highly unlikely.  The value in knowing this difference can help you make better informed decisions in an area where most people feel lost.

Tax evasion is defined as the illegal and intentional underpayment or nonpayment of tax.  If there is a mistake on your tax return, the IRS will give to ample time to rectify the matter.  Those who get locked up for evasion continued to falsify past the initial notices.  So, if you’re the person who tells your preparer to throw a couple extra zero’s at the end of your charitable donations, you’d fall under this category.  You’d also be part of this discussion if you’re claiming a home office deduction but don’t really work at home (the IRS has checked and it CAN happen to you).  If you’re a small business owner who’s claiming a dinner with his wife as “meals and entertainment”, still you!

Tax avoidance is arranging your financial affairs in a manner that LEGALLY minimizes your tax liability.  The simplest example of this would be choosing a state to live in.  While New York has some of the highest state taxes in the country, Texas and Florida don’t have a state tax for non-business returns.  For entrepreneurs, choosing between a C Corp and an LLC is a very important choice in tax avoidance.  Ask your preparer for a tax projection based on several different scenarios. Comparing the results of this exercise will be the best tool in deciding where your money should be going.  You’d find out rather quickly whether it’s beneficial to donate more to charity, the effects of a real estate investment, or how to organize your business.

Tax Avoidance Tip: If you own real estate properties, find something for your wife or kids to do in the venture and pay them fairly.  Work with your accountant to qualify for a home business deduction and don’t forget, you’ll be able to write off the part of your car and phone bills.  It all adds up!

Many companies have made some headlines in past years by utilizing the “Double Irish with a Dutch Sandwich” tax strategy. This commonly used concept would move profits around the globe by setting up foreign subsidiaries is such a way where effective corporate tax rates were as low as 0% for large and highly profitable businesses.  In hopes of driving ratings, some media outlets have a tax evasion undertone, while this type of behavior is perfectly legal.

Effective Tax Rate – The actual rate of taxes you pay after all deductions are considered.  This is different than your tax bracket rate.

So, when you hear about some “evil” person or Fortune 500 company not paying there taxes, don’t jump the gun.  He or she may not exactly be a crook.  The ethics of the matter can and will continue to be debated but the facts are facts.  Avoidance does not equal evasion.

If you’d like specific examples and strategies pertaining to your situation, ask me a question in my closed facebook group or leave a comment below. Thanks!

Eric Estevez
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