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What’s the Difference Between Tax Evasion and Tax Avoidance?

Staying Out of Legal Trouble When Filing Your Taxes

Tax season is rapidly approaching. While there are some legal ways to lower the amount of taxes you’ll owe this year, other approaches could be a criminal offense. Keep reading to understand the different definitions – and consequences – of tax evasion and tax avoidance.

Tax Avoidance

Tax avoidance is defined as any action taken to lower one’s tax liability and maximize their after-tax income. It is a legal strategy through which an individual claims their allowed deductions and credits. Common tax avoidance techniques include:

  • Deducting a charitable donation
  • Deducting Health Savings Account contributions
  • Putting money into a 401(k)
  • Using a student loan interest deduction

Your tax preparation software or tax advisor will be able to help you understand which credits and deductions you qualify for.

Tax Evasion

A taxpayer commits tax evasion when they fail to pay, or deliberately underpay, their taxes. It is an illegal method by an individual or business to conceal income from the IRS in an attempt to pay less. Common examples of tax evasion include:

  • Failing to report income from international sources
  • Not paying taxes for cryptocurrencies
  • Not reporting income from all-cash businesses
  • Not reporting income from illegal activities like drug dealing
  • Paying household workers, such as a nanny, under the table

The Difference

Beyond the difference in legality, tax avoidance is distinct from tax evasion mainly due to the transparency of the acts. A taxpayer who takes steps to claim legal deductions or put money in other accounts to legally lower their taxes is still upfront about where their money goes when they report their taxes. Tax evaders, on the other hand, try to hide aspects of their finances from the IRS.

The Penalty

Mistakes on your taxes are often forgiven so long as you take the time to correct them. Misfiled taxes only become criminal when an individual intended to evade taxes. If it was an intentional act, the tax evader could face a felony charge punished by:

  • Up to five years in jail
  • Up to $250,000 fine, or $500,000 for guilty corporations
  • Prosecution costs

Even if not criminally prosecuted, tax evasion, intentional or not, can incur failure-to-file penalties, underpayment penalties, accuracy-related penalties, and reap interest on the owed penalties.

If you made a mistake on your taxes, you should use IRS Form 1040X to make the necessary changes. If your error resulted in an accusation of tax fraud, you should call our attorneys for powerful legal defense. Contact us online or at (865) 544-2010 for more information.