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Tax Evasion vs. Tax Avoidance

tax evasion

In the world of finances, tax evasion and tax avoidance are two terms that often get confused and yet have completely different meanings. 

Tax Evasion

Simply put, the term tax evasion means not paying the taxes that you owe. Penalties for this type of infraction can range anywhere from fines to jail time depending on intent. Intentionally foregoing the payment of your taxes will most likely result in hefty punishment.

Don’t believe us? Go read about actor Wesley Snipes' recent 3 year stint in prison after opting out of paying his taxes. 

Important things to remember when trying  to “Avoid” Tax Evasion

  • Declare your independent contractor’s income
  • Don’t inflate business expenses
  • Report income earned in other countries
  • Don’t declare personal expenses as business expenses

Tax Avoidance

Tax avoidance on the other hand, is when you arrange your income in a manner that legally allows you to pay the lowest amount of taxes. And yes, this is legal. In fact, there’s an entire industry built around this concept—it’s called tax consultancy—something we love helping clients with here at Bookly

Speaking on the constitutionality of the matter, Judge Learned Hand said:

Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands. 

In most cases, tax avoidance is more applicable to higher income earners. There are less ways for low income individuals to avoid payment of taxes. This fact has been at the helm of much political debate—something we’ll leave to the pundits. 

Methods of Tax Avoidance

  • Deferring income (401k)
  • Getting income through Capital Gains
  • Using the primary residence capital gain exclusion to its full effect

Audited? Don't Panic! Here's How to Handle it.

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Nothing strikes fear into the hearts of small business owners quite like the a-word. Whether it’s the IRS or state taxing authorities, having someone tell you they want to audit your records is a fraught time even for the most organized business owner.

You think you filed your tax returns correctly, but what if you made a mistake? Could you have to pay a huge penalty? Could you even go to jail? 

Unfortunately, small business owners are a bit more likely to be audited than the general public because they self-report info on the Schedule C. It’s tempting to panic when you see the word “audit” but don’t. Just like with many big, bad boogeymen, this one isn’t as scary as it seems once it knocks on your door. 

A FEW TIPS TO HELP YOU HANDLE YOUR AUDIT WITH FINESSE... 

READ THE LETTER CAREFULLY

Think of an auditor as a man in a black suit and dark sunglasses whisking you away to a non-descript office complex to go over your entire life? Believe me! It isn’t as bad as all that. 

In fact, the vast majority of audits are carried out via the U.S. mail. In fact, the IRS will never call or email you, so if someone claiming to be from the agency contacts you in any form other than a letter, be wary. 

If you do get a letter, keep in mind that most times, the IRS is only auditing a portion of your tax return. That said, read the letter carefully. In most cases, the IRS simply wants clarification on one part of your tax return. Once you have answered their request they will let you know in writing what they’ve decided, and you even have a chance to appeal. See, that wasn’t so scary? 

Gather Documentation 

If the IRS or your state’s taxing authority comes calling, be prepared to back up your tax claims with documentation. If the audit is mileage related, for example, be prepared to show an auditor your mileage log. 

Do be careful about what you show an auditor. Only give them enough information to answer the question they asked. If you offer up more information, such as your whole “Taxes 2012” file, they are allowed to expand the scope of the audit. And nobody needs more trouble!
From there, be sure to send in any requested documentation by the deadline listed on your letter. 

Watch for Red Flags

If you must meet with an auditor, do not meet with him or her at your home. Instead request to meet at a local tax office or even, if you have retained one, your tax attorney’s office. 

Before you meet the auditor, know your Taxpayer’s Bill of Rights. If you feel at any time like the audit is going badly, you can request to pause and consult with an attorney. If the auditor mentions serious crimes, such as “tax fraud” then it’s in your best interest to consult an attorney. Fortunately, when you’re a small business owner simply trying to do the right thing you likely won’t run into such a dire predicament.