What’s Difference Between Tax Planning, Tax Avoidance, And Tax Evasion?

For anyone venturing to learn more about taxes, simple terms that are routine in the industry can seem complex at first. It’s important to understand the differences between these terms, whether you’re filing as an individual, small business, or large corporation.

People often get confused about the difference between tax planning, tax avoidance, and tax evasion. While two of these are proven strategies that citizens and businesses can use to reduce their tax liability, tax evasion is illegal and should be avoided at all costs. Here are the differences between these three key terms. 

How Tax Planning Can Help You and Your Business

There are many benefits to tax planning. Whether you’re an individual or a business, proactive tax planning can help you save your hard-earned money and alleviate some of the stressors tax seasons brings. 

For many, tax planning is on their to-do list but is not a priority and is often addressed last minute. This doesn’t set any individual or business up for success. Working with a reputable tax firm saves a lot of valuable time and pays dividends down the road. It can include projecting and financial forecasting for the upcoming months as well as using data from past tax years along with projected earnings to make accurate assessments. This forecasting helps eliminate the worry of an unexpected tax burden. It also enables business owners to make accurate assessments of where they will be financially at the end of a fiscal year, setting them up for more tactical investment planning and savings strategies.

It is vital to be aware of your financial health—whether you are looking at your personal bank account or your company’s account—so you can accurately forecast your earnings. This helps you prepare for unexpected situations, such as a large tax bill during an unexpectedly prosperous fiscal year. If your business is not doing as well as in years past, tax planning can also deploy strategies to help you legally reduce the amount of taxes paid.

What Is Tax Avoidance?

Tax avoidance is a strategy that uses the maximum amount of deductions possible to lessen your tax liability. This is done in several ways; some strategies include using tax credits or bundling tax deductions on charitable contributions so that you can claim itemized deductions which will be on the higher side rather than the standard deduction

One popular example of tax avoidance is taking a child tax credit. A child tax credit is a benefit granted to the taxpayer for each dependent child. Recent legislation increased the maximum annual credit from $2,000 per child (under 17) to $3,000 per child (under 18), or $3,600 for children younger than 6. This credit is fully refundable and will be distributed to eligible taxpayers in advance payments monthly. Parents do not have to owe taxes to receive this benefit. 

Another common way to practice tax avoidance is by saving for retirement. This includes individuals who contribute to an IRA or employer-sponsored retirement plan, which are taken from your pre-tax earnings and drawn directly from your paycheck. Other strategies include capital gains tax and mortgage interest, which is deductible on both a first and second home, but not a third, provided certain criteria are met.

Numerous methods can be used to achieve tax avoidance. Working with an expert will ensure that you identify the methods that are beneficial for you. 

What Is Tax Evasion? 

Tax evasion is any illegal means by which an individual or corporation willfully avoids paying taxes, whether by evading assessment or payment itself. This does not include simple mistakes made when filling out your taxes. It must be intentional for the IRS to consider it an evasion. 

Examples of tax evasion include, but are not limited to, avoiding reporting income, neglecting to file your tax return, deliberately underpaying your taxes, or taking advantage of deductions that you are not eligible for. Significant fines accompany tax evasion, and those convicted of tax evasion must pay back their initial tax liability plus interest on top of the potential fines, which can add up to quite a large sum. If convicted, more serious tax evasion can garner fines to the tune of $500,000, and certain cases may even warrant jail time.
The line between tax evasion and tax avoidance can be thin. Make sure you’re working with a reputable accounting firm to minimize your tax liability and maximize deductions. Contact AG FinTax today for a free consultation and see how we can help.

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