What Is Tax Evasion [Examples, Penalties & Tax Avoidance]

There are many things you shouldn’t do in your lifetime, and one of the biggest is tax evasion. While the idea may seem tempting, it is important to understand not only what is tax evasion, but also the risks associated with it. In this article, we will discuss everything from the definition of tax evasion, various ways people do it, and the penalties of being caught.

What Is Tax Evasion?

Tax evasion is the act of not paying your due taxes on time to the IRS. Individuals may engage in tax evasion for many reasons, such as seeing them as an unnecessary burden on their income. Others might wish to keep their money to themselves, rather than giving it to the government.

There are mainly two types of tax evasion. The first one is the evasion of assessment, which includes not informing tax authorities of your exact income. If income is not reported by someone, authorities do not possess a tax claim on them. This is one of the most common tax evasion examples.

The other one is the evasion of payment. This includes not paying taxes you owe, even though your income is reported. Some may only pay a part of their taxes and leave out the rest. This nonpayment or underpayment of tax is also one of the largest ways to engage in tax evasion.

Tax Evasion Examples

There are many ways to evade taxes that a taxpayer like yourself might consider using. Here are a few of the most utilized:

Not Reporting All Your Income

Ideally, you should report all the money you make to the IRS, especially funds from side businesses or tips. Tax authorities consider it a federal offense if you don’t, as it implies to them that you’re purposely trying to lower your taxes. When it comes to filing, you can get help from business tax software to determine all your income and the right amount of tax to be paid.

Using Unearned Deductions

Tax deductions or tax credits are two of the legal ways you can lower your tax liability. However, many people try to lower their taxes by applying unearned deductions like credit for a nonexistent dependent or creating a shell company. This is an illegal activity that can lead to a serious tax evasion punishment.

Purposely Underpaying Taxes

Missing out on paying a part of your taxes here and there does not make the IRS knock at your door. If you fail to pay purposely and repeatedly, though, it is considered tax evasion. Before you think you can pull it off, the IRS is pretty good at determining whether tax amounts have been entered maliciously or honestly.

Not Filing Taxes at All

Lastly, tax evaders even sort to this extreme. Instead of going through the various ways to reduce their taxable income, they don’t file taxes at all. One way some do this is by creating a fake social security number, or by not reporting income at all. Both these types of tax frauds can lead to severe penalties from tax authorities.

Tax Evasion vs Tax Avoidance

Tax evasions and tax avoidances share similarities and differences. Both tax evasion and tax avoidance aim to reduce one’s taxes by lowering taxable income.

However, tax evasion is illegal, whereas tax avoidance is legal. The government offers various exemptions like retirement plans, mutual funds, municipal bonds, and tax credits to reduce one’s liability. Using these methods to reduce your income falls under tax avoidance, but is totally legal.

Another major difference is that tax avoidance is also a form of investment, whereas tax evasion is simply preventing your money from being taxed. Tax evasion is also about keeping the IRS in the dark about your income, which is considered against the law.

Tax Avoidance Examples

To give you a better idea of what tax avoidance is, we’ve listed some examples in detail below.

Work Deductions

You can opt for several work deductions from your pre-tax income. All these are expenses that you incur while doing your job or business, which is technically not an income. It includes union dues, transportation costs, tools, etc.

Home Equity

The Internal Revenue Service (IRS) tax code allows taxpayers to deduct their home equity amount from their income. It is one of the most common ways people reduce their taxes while paying a mortgage at the same time.

College Savings

If you’re a parent who wants to save for your child’s college education, you can do that by utilizing a 529 Plan, otherwise known as a Coverdell Education Savings Account. This can be set up with your pretax income, thereby reducing your overall taxable income. If you’re a working individual, your education costs are also deductible.

Health Savings

The government encourages you to plan for your health, meaning you will not be charged with a tax fraud sentence if you act in that interest. However, you should only do this through a health savings account, which is tax-deductible.

Retirement Savings

Retirement savings accounts like 401(k), 401 (b), Roth IRA, and Roth 401(k) not only help you save up for future retirement but also decrease your taxable income.

Key Takeaways

Tax Evasion Penalties

A tax evader can face serious consequences if they engage in tax evasion. Here are a few potential consequences:

Not Filing a Return

If you fail to file returns at all, you will be charged a fine. The fee is usually 5% of the taxes you owe each month, with the maximum penalty being 25%. If you still fail to file returns for more than two months after, you will be charged either a $435 flat fee or the amount of taxes you owe. This may seem like a small penalty, but the amount can really add up.

Filing a Fraudulent Return

Taxpayer obligations include filing a correct tax return. If you’ve filed a fraudulent report by mistake, you can still be charged with civil tax penalties; the most common include paying 20% of the underpaid tax as a fine.
However, if you’ve misled purposely, you’ll be charged with civil fraud carrying a penalty of 75% of your underpaid tax. In severe cases, a tax evasion sentence means jail time.

Failing to Pay Taxes

If you don’t pay taxes and are caught, you can be charged with penalties according to your state’s tax system. In extreme cases, if the amount of tax evasion is too high, you can be sent to prison for up to 5 years!

Conclusion

Tax evasion is not paying taxes that are due to the government. Methods involve false tax reporting, not reporting taxes at all, or only a part of them. Tax evasion should not be confused with tax avoidance; the latter is a legal way to reduce your taxable income using tax deductibles like home equity. Not paying your taxes can lead to huge fines, and in severe cases, criminal charges with jail time for up to five years.