A lot of business owners and tax payers confuse tax avoidance and tax evasion. Confusing the two concepts can cost you! As you know, the Internal Revenue Service (IRS) law infers that you are guilty until proven innocent. I don’t want to be audited; hence, going nuts with iffy deductions that will result to an audit has never been on my agenda. Many tax payers or business owners operate on this same field- “whatever you do, no audit!”
First thing First – Tax Planning
Most tax payers do not pay attention to their future tax bills or plan to reduce their tax bills using tax planning. Hence, tax planning is never on their to-do list. Tax planning is a process of looking at various tax options in order to determine when and how to eliminate or reduced huge tax bills.
Understanding the tax system is the key to demystifying the puzzle. How do I reduce my tax liability? What deductions am I missing? How do I avoid crossing the line with my deductions? The answers to these questions are embedded in the understanding of the difference between tax avoidance and tax evasion.
Tax Avoidance Strategies
Tax avoidance is legal. It is the practice of avoiding paying too much taxes or reducing your tax bill. The tax system is very thorough but also has its weakness, otherwise called “tax loopholes.” Invariably, tax avoidance is the use of the existing tax laws to your advantage. Understanding the tax laws or engaging accountants who understand the tax laws is the key to an effective use of tax avoidance mechanism.
The IRS clearly distinguishes between legitimate tax schemes and abusive tax schemes. Legal tax avoidance schemes are intended to generate income in a tax-preferred way.
Common Available to Avoid or Minimize Taxes?
The list or strategy below is not exclusive or exhaustive. These are few ways by which you can reduce or minimize your tax liability.
Income deferral is a practice of postponing the receipt of income until after midnight on December 31st which allows the income to be taxable for the New Year and need not be claimed on the current year's tax returns. An effective use of this strategy requires core understanding of the timing of your cash inflows.
Tax deduction is another key way to reduce or minimize your tax bill. Expense items incurred within the tax year that you can deduct from the subtotal of taxes to be paid. There are both "above-the-line" and "below-the-line" deductions which include the following:
A tax payer may deduct contributions to qualified charitable organizations as long as the deduction does not exceed 50% of adjusted gross income. Excess deductions can be carried forward to the next five taxable years. Your adjusted gross income includes your income adjusted downward by specific deductions, but not including standard and itemized deductions.
Tax Payers may use retirement contribution to shelter income. Some common retirement funds used as tax shelter include IRAs, 401(k), SEP, and 403(b). This is why retirement plans have contribution limits.
Tax evasion is the use illegal means to avoid the payment of taxes. It is a practice of intentionally avoiding paying the true tax liability. Tax evasion schemes involve an individual or corporation misrepresenting their true income to the Internal Revenue Service. Misrepresentation may take the form either of underreporting income, inflating deductions, or hiding money and its interest altogether in offshore accounts.
To avoid confusing the difference between tax avoidance strategies and tax evasion schemes, please visit the IRS website at www.irs.gov or contact your Tax Accountant. Neglecting effective tax planning will cost you by resulting to huge tax bill.
© 2017 PAMC.