"They can't collect legal taxes from illegal money." These rather boastful words are those of the notorious Chicago gangster, Al Capone — before the IRS caught up with him in 1931 and he was sentenced to 11 years in prison for tax evasion. Yikes!
Alright, maybe you're no Al Capone, but are you unknowingly filing incorrect returns or failing to report critical information? The Internal Revenue Service (IRS) has a reputation for being a stickler when it comes to paying your dues to Uncle Sam, and understanding the difference between tax avoidance vs. evasion could save you a heap of trouble that ol' Capone had to learn the hard way.
Tax Avoidance vs. Evasion: What Is Tax Avoidance?
It's important to note that there is a big difference between tax avoidance vs. evasion. Tax avoidance is defined as using legal means to try and minimize your tax obligations whether for your personal or business income. Let's unpack that. When a business avoids taxes, it does so by maximizing its claim amounts for deductions and credits, leaning toward specific investments that come with tax advantages and seeking out other loopholes that enable them to legally pay fewer taxes.
While a legitimate practice under the law, it's important to note that the IRS wasn't born yesterday. Not only are they very aware of the numerous loopholes and methods that businesses use to avoid paying too much in terms of taxes, but they are very diligent about reviewing and auditing various legal tax shelters to ensure that every penny is accounted for — including any side hustle income you might have.
What Are Some Examples of Tax Avoidance?
Saving for retirement. Yep, if you've ever put money aside in an employer-sponsored retirement plan before starting your business, you were legally avoiding taxes.
Business expenses. Your car lease, mileage, computers, equipment, paper and a bright red Swingline® stapler can be written off as necessary to your business activities.
Offshore bank accounts. Thanks to certain loopholes in the U.S. Tax Code, storing your money in overseas accounts to save on tax is legal — so long as you report it.
What Is Tax Evasion?
Tax evasion is different. Simply put, the difference between tax avoidance vs. evasion is that evasion is illegal and carries hefty criminal charges. This is when a business reports less revenue than has been earned through all business activities in a given year. Cash jobs, under-the-table deals and similar tactics result in underpaying the government with regard to your tax obligations.
To be charged and punished for tax evasion, the IRS must prove that your actions were willful and intentional, and if they can do that, the hammer will fall, so to speak. Most businesses are wise enough to play by the rules, but according to the United States Sentencing Commission, there were still 370 tax fraud offenders sentenced in 2021. It's worth noting that that number has come down by 38.1 percent since 2017.
What Is Tax Evasion and Examples?
Falsifying tax documents. If you alter paperwork to make it seem like you made less income or list expenses or deductions that are inaccurate or don't exist, that's tax evasion.
Reporting under a false name. If you file a return under a false name in order to divide income so as to pay fewer taxes, that's tax evasion (and possibly identity theft).
Failing to report income or offshore shelters. If you agree to under-the-table, tax-free deals or fail to report that you have a wad of cash parked in the Cayman Islands, that too, my friend, is tax evasion.
How Can You Ensure You Aren't Accidentally Avoiding Your Tax Obligations?
Now that you have a better understanding of tax avoidance vs. evasion, you can take steps to ensure that you aren't putting yourself or your business in a position of risk (or blatant criminal activity). The best thing you can do is learn when to report your LLC taxes on time, how to file your taxes based on your business entity type and make sure that you keep records of everything you do. This process can be made much easier if you simply have a professional (such as Incfile) take care of it for you to alleviate any additional stress.
If you're a sole proprietor or LLC owner, it's likely that your business income goes directly to you in the form of personal income. This is called pass-through taxation, and it means that your business doesn't pay taxes of its own — you are taxed personally for all net income.
If you do anything in your business that requires you to look over your shoulder or talk in a hushed voice, you'll probably want to think again. Businesses that stick to the rules and report all sources of income don't have to worry that their owners might one day be staring at a brick wall in a 70-square-foot prison cell!
What Happens If You Try to Evade Your Tax Obligations?
Remember, there are clear differences between tax avoidance vs. evasion. If you willfully evade paying your taxes, you could be charged with a felony and receive a hefty sentence. Fines and penalties could be anywhere up to $100,000 for an individual or $500,000 for a corporation, and you may even have to go to prison for several years. Don't forget the prosecution and defense costs, either!
The bottom line in the tax avoidance vs. evasion discussion is that you can avoid taxes so long as you play by the rules, but you cannot purposefully evade your taxes without criminal prosecution. Luckily, Incfile can help to ensure that you stay on the right side of Uncle Sam and Johnny Law with our accounting and bookkeeping tax service for small businesses. Sign up for a free tax consultation today, and rest assured that you'll have a partner who won't let your hard work go to waste.
Chad is a freelance writer and former project manager focused on presenting information on SaaS, technology and business formation.