What is the difference between tax evasion and tax avoidance, and how will the I

Question

What is the difference between tax evasion and tax avoidance, and how will the IRS determine the difference? Does the IRS differentiate between felonies and misdemeanors? What are some examples of each? Are the use of Tax Shelters, as defined by the IRS, avoidance or evasion? If you recall, "aggressive" tax positions are laws interpreted two different ways - another is where a decision in this area of the law has never been made, and you are going to test how far you can go.

In some countries like Brazil and Russia, up to 40% of their economy is considered "black market" (i.e. not declared). In these countries, the businesses keep two sets of books and records - the real books, and those for the taxing authorities, or no books at all. It is not uncommon, in these countries/cultures, for it to be customary to openly avoid paying taxes - commonly accepted in their culture. Just imagine a country like Italy or Greece where everyone tries to not pay social security taxes, and yet they want retirement and disability benefits and more. How do you not pay into a system, and yet want all the benefits?

In the US, while few persons "like" paying taxes, we don't look favorably upon others that evade taxation. Few persons "openly" evade taxation, and those that do risk being turned in to the IRS (even by their own spouses). And yet, even with that sense of obligation, we have about 8-10% of all taxpayers evading taxation.

Here's a true personal story from the past two weeks. I started negotiations to purchase a small tourist based boutique shop in my town. The owner wants (for illustrative purposes) $200,000 for the business. If you ever bought or sold a small business, then you know valuations are based on a multiplier of annual Net Cash Flows (yes, you can discount and much more, but it's all based on cash and not accrual accounting). This particular small business keeps two sets of books - one for tax, one for cash and they don't declare all their cash receipts. Of course, legally that is never a great idea, and many small businesses attempt to not declare all their sales. And of course, the road is littered with the names of those that have been charged criminally by the IRS. However, this two sets of books becomes a real problem if you want to sell your business to someone - particularly if you have to justify the cash flows, and if the buyer has to borrow funds for the purchase. The current owner of this boutique store simply cannot justify their earnings, and worse - the only buyers they will get are going to be other scrupulous persons that are also willing to cheat the government and others. Obviously, I did not proceed with negotiations since the only amount I was going to base my purchase price is on "declared" revenue. Plus I hate doing business with cheats.

If we only ensured that all persons paid their taxes, we might not even have a spending deficit each year. Remember a few weeks ago when we talked about ideas to increase revenue? Well, just getting everyone to pay their taxes is one.

And that's why we have IRS enforcement.

Explanation / Answer

Tax avoidance is lowering the tax bill by planning and organising the transactions ,so as to maximise the after tax income.Tax avoidance can be done through proper advanced tax planning , with the help of tax professionals.This is perfectly legal. whereas,

Tax evasion is a crime- to reduce tax liability by concealment and deceitful practices- done wantonly.

The IRS determines the difference by noting whether the actions were taken with fraudulent intention.

Keeping two sets of books,deliberately omitting/under-stating income, claiming personal expenses as business expenses,etc. are some of criminal tax-evasion activities.

Misdemeanors are less serious crimes like mjnor thefts/drug offences/traffic offenses- punishable with fines and/or jail terms usually less than a year.

Felonies are more serious crimes like murder/rape/etc.- punishable with substantial fines and prison terms usually more than a year and even death penalty.

Both are treated as criminal violations by IRS under Exhibit 25.1.1-1.

Tax shelters are means to minimise one's tax liability. They can be legal/illegal.

Legal tax shelters like 40(1)k of the IRS( employer sponsored -to reduce tax liability as well as to save for retirement)

and limited partnership arrangement are tax avoidance mechanisms.

Investment in off-shore ventures are illegal tax shelters and hence tax evasion. IRS may charge a fee such abusive shelters- which avoid or evade tax unreasonably.

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