What are the Differences Between Tax Evasion, Tax Avoidance and Tax Planning?

If you own a business, you generally have the right to organize it in a way that ensures you pay no more taxes than necessary. This strategy, known as tax avoidance, involves using legal means to reduce taxes.

It is not the same thing as tax evasion, which is the practice of violating your country's laws and paying less than the minimum amount of taxes. Rather, tax avoidance is the practice of setting up your business in a way that ensures it will be taxed fairly by your country's government.

Table of Contents:

• 1. What is Tax Evasion?
• 1.1 Objective Of Tax Evasion
• 1.2 Methods Of Tax Evasion
• 1.3 Consequences Of Tax Evasion
• 2. What is Tax Avoidance?
• 2.1 Objectives Of Tax Avoidance
• 2.2 Methods Of Tax Avoidance
• 2.3 Consequences Of Tax Avoidance
• 3. Differences Between Tax Evasion and Tax Avoidance
• 4. Benefits of Tax Planning
• Tax Avoidance vs Tax Evasion: Final Considerations

1. What is Tax Evasion?

Tax evasion is the use of any illegal methods to reduce one’s tax liability. This usually involves fraudulent techniques such as purposefully under-reporting taxable income/profits, exaggerating deductible expenses, or illegally not paying taxes altogether. 

1.1 Objective of Tax Evasion

The objective of tax evasion is quite obvious. An individual engages in tax evasion so as to greatly reduce the amount of taxes they have to pay on their income/profits. Taxpayers are often attracted to these illegitimate means of tax evasion as they promise large savings on taxes and require less effort and planning than legitimate tax avoidance techniques. That being said, the potential consequences are much more severe. 

1.2 Methods of Tax Evasion

There are many methods for trying to evade taxes. Whilst some involve complex and elaborate schemes to hide millions of dollars from the IRS, other instances of tax evasion happen at a much smaller scale, and one can fall into these types of unlawful practices more easily than you’d think. Examples include:

• Making false statements on your tax returns, or providing inaccurate or incomplete information. 
• Exaggerating tax deductions such as business expenses, charitable contributions etc. above their real level, without providing legal proof or by falsifying proof. 
• Declaring only a proportion of your income for tax purposes and concealing the rest. There are many ways to conceal income, such as not declaring cash income, hiding offshore income streams, falsely reporting the income in someone else’s name (perhaps a spouse or child who is in a low tax band), and many other inventive and dubious techniques. 
• Illegally transferring or hiding assets, especially in the case of overseas assets and bank accounts.

1.3 Consequences of tax Evasion

Tax evasion is, by definition, illegal and fraudulent activity. Therefore, there can be serious legal consequences. This can range from heavy fines to actual imprisonment. The severity of the punishment will depend on many factors such as the amount in question, the means employed and the intent of the taxpayer. Wilful tax evasion is considered a serious crime in most jurisdictions. 

2. What is Tax Avoidance?

Tax avoidance is the use of legitimate and legal methods to reduce one’s tax liability. 

2.1 Objectives of tax avoidance

The purpose of tax avoidance is much the same as tax evasion. Taxpayers use various methods of tax avoidance to minimise the amount of taxes they are liable to pay. The important difference lies in the means of achieving this objective, as well as the potential consequences.

2.2 Methods of tax avoidance

There are many ways to reduce taxable income and minimise one’s tax burden which are completely legal and above-board. Some methods include:

• Making use of tax deductions and credits to reduce your taxable income. These include various business expenses, tuition costs, medical expenses, and charitable donations.
• Making use of tax deferral plans to delay the payment of taxes. An example is an individual retirement account (IRA), for which taxes on the invested funds are only paid when the funds and the corresponding interest payments are withdrawn.
• Using employee retirement plans to protect revenue from being taxed.
• Becoming a tax resident or citizen of a low-tax jurisdiction. This can be a highly effective way to optimise and minimise taxes, and is often used by US citizens as a way to renounce their US citizenship to stop paying taxes in the States. 
• Making use of different tax-efficient financial vehicles such as private companies, trusts, foundations etc. The benefits can be maximised if these financial structures are formed in tax-friendly offshore jurisdictions.
• Gifting your wealth to your heirs before you die so as to reduce the amount of estate tax they will have to pay. There are also other effective estate planning methods to reduce taxes, such as using tax-efficient trusts. 

2.3 Consequences of Tax Avoidance

As long as the tax avoidance methods which are used are clearly within the bounds of the law, there are no real negative consequences of tax avoidance. However, you should be incredibly careful when taking measures to avoid taxes to ensure that they are all legitimate and fully comply with the tax laws in your given jurisdiction. There is often a fine line between legitimate tax avoidance techniques, and illegal tax evasion. It is recommended to seek sound legal advice and support when trying to implement tax avoidance methods to make sure that no mistakes are made. 

Another point to be aware of is that, although legitimate tax avoidance methods are considered legal, they often make use of legal loopholes and can sometimes be morally questionable depending on the exact methods employed. You should therefore also be aware of the moral implications of whatever tax avoidance methods you use, as well as the potential bad publicity or public scrutiny you may get. This is especially important for celebrities, politicians, and other public figures.

3. Differences Between Tax Evasion and Tax Avoidance

The fundamental difference between tax evasion and tax avoidance is that tax evasion is illegal/fraudulent whereas tax avoidance is legal. There are a few other defining features and differences between the two, which are summarised below:

• Intention: The intention behind tax avoidance is to optimise and reduce one’s tax liability, whereas the intention behind tax evasion is to deliberately evade paying taxes which are actually owed.
• Legality: Tax avoidance is legal whereas tax evasion is illegal and fraudulent. Tax avoidance sometimes takes advantage of legal loopholes and can be at the fringes of what is considered legal. One has to be careful to not overstep the legal lines in which case tax avoidance would turn into tax evasion. 
• Methods: Tax avoidance makes use of various financial tools and methods to reduce taxable income, alter the form the income takes so as to qualify for lower tax rates, or increase the amount of legitimate tax deductions and credits. Tax evasion uses fraudulent and illegal techniques to hide taxable income, falsify and overinflate deductions, or evade reporting for taxes altogether. 
• Timing: Tax avoidance is usually a prospective method for reducing taxes. This means that it is a method to avoid and/or reduce taxes before they are incurred. By contrast, tax evasion is usually retrospective, in that it seeks to escape paying taxes which have actually already been incurred and are legally due to be paid. 
• Consequences: There are few negative consequences of tax avoidance as long as the laws have been strictly adhered to. However, some tax avoidance methods may be morally dubious, even though they are legal, and there could be negative implications to this. Tax evasion is illegal, and the consequences can range from moderate to severe. Tax evasion may result in heavy fines and/or prison sentences. 

4. Benefits of Tax Planning

“Tax planning” usually refers to a more intelligent, wholistic and long-term strategy for optimising and reducing taxes. Tax planning makes use of various legitimate tax avoidance methods in an integrated and structured way. It involves considering various aspects of your financial situation and finding the right vehicles and solutions to reduce your overall tax burden. Methods include:

• Acquiring dual citizenship and/or permanent residence in a tax-efficient jurisdiction.
• Using multiple financial vehicles that reduce taxes such as offshore companies, asset protection trusts etc...
• Considering various tax-efficient retirement funds, investments, offshore accounts, and other structures. 
• Evaluating your entire asset portfolio with the help of a tax expert who can help you to create an intelligent and comprehensive tax planning strategy.

Effective tax planning has the benefit of being comprehensive, as it takes the entire picture into consideration. It doesn’t just look at individual, haphazard ways to avoid taxes. Rather, the intention is to come up with a multi-faceted and long-term strategy to consistently reduce your overall tax liability. Good tax planning is also considered to be the most morally sound and safest option available for reducing taxes. 

Tax Avoidance vs Tax Evasion: Final Considerations

There are many complex and subtle laws applicable to taxation. Many people make the mistake of trying to take the convenient route of reducing taxes, which involves just illegally evading them altogether. Tax evasion promises immediate financial benefit and convenience, but it also comes with its legal consequences. It is important to understand these consequences and know that there are other, legitimate ways to reduce your tax liability.

This is where the importance of tax avoidance and intelligent tax planning comes in. Through acquiring a more thorough understanding about how taxes work, the laws which apply, and the various legal methods available to legally reduce your tax liability, it is possible to minimise taxes whilst remaining safely within the legal framework of your jurisdiction. 

In doing this, it is highly recommended to seek the professional advice of a tax expert. An expert can assess your situation and help you to find the best solutions for legally reducing your taxes. They can also warn you if you are currently engaging in any illegal tax practices. Putting in just a little more time and effort into legitimate tax planning can be hugely beneficial in the long run. You will also be more at ease knowing that you are not operating outside the bounds of the law, and will not be subject to unexpected legal consequences.