What is Tax Avoidance and How to Avoid Paying More Taxes

How many of you have heard the term tax avoidance before? Probably none, because it’s such an uncommon term that most people probably don’t even know what it means. But how many of you have heard the phrase tax loopholes? Most of you, right? Well, those are actually forms of tax avoidance (or at least they can be). If you want to learn more about what tax avoidance means, how to use it as part of your own tax strategy, and the different types of tax avoidance, keep reading.

What is Tax Avoidance?

What is tax avoidance? It seems like a simple question, but in truth, it’s very complex. In short, tax avoidance means using specific legal methods to reduce or eliminate your tax liability (the amount of taxes you owe). The reason tax avoidance can be so complex is that there are many different ways you can use laws and loopholes to reduce your taxes. And while some of these tactics seem like they must be illegal—they actually aren’t.

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The Different Types of Tax Avoidance, Or Tax Loopholes

There are various types of tax avoidances, and you should always speak to an accountant about this. U.S. taxpayers can use credits, deductions, exclusions, and loopholes to get out of paying taxes. Here are just a few of the tools available to taxpayers to avoid taxes.

Expenses

You can use deductions through your workplace to avoid taxes. You may be able to claim certain expenses that are not reimbursed through your employer on your annual tax return. These costs are considered necessary in order to do your job. Some examples of workplace expenses include mileage on a personal vehicle and union dues. Other expenses may include tools or services that you may need to use.

Deductions For Retirement Savings

To save money for your retirement, you are most likely doing tax avoidance, and that’s a good thing. Every individual who contributes to an employer-sponsored retirement plan or invests in an individual retirement account is participating in a tax-avoidance transaction.

If the account is a so-called traditional plan, the investor will immediately get a tax break equal to the amount he or she contributes each year, up to a limit that is revised each year. Income taxes on the money is owed when it is withdrawn after the saver retires. The retiree’s taxable income will be much lower, and his or her taxes will be lower as well. That’s tax avoidance.

Roth IRA plans let investors save tax-free and enjoy a tax break when they withdraw the funds in retirement. With a Roth IRA, all the money invested can be taken out tax-free. Roths allow people to not have to pay income taxes on their money if they just contribute it during the year.

The Standard Deduction

A standard deduction is that part of your income that’s exempt from taxes. To take the standard deduction, the Internal Revenue Service only requires you to use Form 1040’s Schedule A if you haven’t listed your own itemized deductions. Depending on your filing status, age, and whether you are disabled or claimed as a dependent on someone else’s tax return, your standard deduction will be a certain amount.

You should always ask a tax professional or tax lawyer about standard deductions.

Offshoring

Corporations and high-net-worth individuals (HNWIs) take advantage of the loopholes in the U.S. Tax Code to relocate their money to offshore tax-havens which has lower regulations, lower tax, lower risk, and more confidentiality. By setting up subsidiary or bank accounts overseas, these taxpaying entities can avoid paying (higher) taxes in their home countries.

Tax Avoidance Is Not An Excuse For Tax Evasion

The IRS defines tax avoidance as an attempt by a taxpayer to reduce or eliminate taxes through legal methods. In other words, it means taking advantage of deductions, credits, exclusions, and other special rules in order to pay less tax than you otherwise would.

It’s perfectly legal, and it may be controversial. However, many people take full advantage of what their government offers them in terms of avoiding paying more taxes. By minimizing your taxable income, you can ultimately save money on paying taxes overall.

While both tax avoidance and tax evasion may involve managing income in order to avoid taxation, they are significantly different methods. Avoiding taxes is legally defensible, but evading them is, at the very least, illegal.

Tax evasion happens when people purposely avoid reporting their income, such as tips or bonuses. If you deliberately refuse to report income, such as tips or bonuses, you are guilty of tax evasion. Claiming a tax credit to which you’re not entitled can also be considered tax evasion.

A taxpayer may evade paying taxes by not filing taxes or by not paying taxes even if they have filed a return.

Evading taxes is an offense that can carry harsh punishments, such as hefty fines, imprisonment, or both.

The Bottom Line

It’s important to note that tax avoidance, in the general sense, isn’t always considered a good thing. While we use the term tax avoidance when referring to legal methods of reducing your tax burden, you might be familiar with another kind of tax avoidance — the illegal kind.

For example, if a business owner took cash out of his company’s checking account and didn’t report it as income on his taxes, he’d be engaging in tax evasion (the actual criminal term for evading taxes) instead of avoiding paying more in taxes.

As you can see from our definition above, there’s a distinction between avoiding taxes by legal means and doing so illegally — but both types involve taking certain actions in order to reduce the amount of money that the IRS expects you to pay.

Legal Favor
Legal Favor

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