Most people are looking for a way to reduce their tax bill, but it can be daunting to figure out how to minimize tax liabilities without getting on the IRS’ radar. Despite similar terms, tax avoidance and tax evasion have key differences that can help individuals and families make the best financial decisions for their situation.
Review this guide to find out how to reduce tax liabilities the right way.
What is Tax Avoidance?
First, taxpayers need to know that tax avoidance is entirely legal. It’s even quite common – something as simple as the earned income tax credit is a tax avoidance tool. Taxpayers frequently reduce taxable income through employee retirement plans, IRA accounts, tax deductions, and tax credits.
Tax avoidance is effectively an investment and tax planning strategy. People can minimize their tax liabilities while maximizing the earning potential of their assets.
Tax evasion is not considered a tax planning strategy. When people evade taxes, they find ways to invest in or transfer their assets to countries with lower – or no – taxes. Tax evasion can take the form of underreporting or failing to report income, as well as not paying whatever taxes are owed.
Take note that tax evasion is a federal crime in the United States. In the fiscal year 2019, the IRS completed 1,183 legal-source tax case investigations, with 663 referred for prosecution.
Tax Avoidance vs. Tax Evasion: What is the Difference?
The most noticeable difference between tax avoidance and tax evasion is legality. However, there are more subtle differences to understand that could potentially save someone time and money (or a criminal record!).
- Tax avoidance is something the government encourages through tax incentives and credits, whereas tax evasion can land someone in court.
- Tax evasion is an intentional effort to avoid paying taxes you owe, but tax avoidance is a deliberate effort to use resources and tools that lower tax bills.
- Tax avoidance is something people can get professional help with, and tax evasion is something that professionals will actively avoid.
Thousands of tax codes offer credits and incentives to taxpayers, including individuals, freelancers, consultants, and small business owners, that want to optimize their tax avoidance strategy. Anyone who needs help paying off their taxes can find help with tax relief programs.
Tax Planning and Avoidance Strategies to Manage Tax Liabilities
The good news is that anyone who wants to avoid the consequences of tax evasion can use tax avoidance strategies. Professionals commonly use these critical methods.
Tax Planning Strategies
While tax planning is a dedicated profession in itself, it’s not exclusive from investment planning. Several different investment strategies can reduce tax liabilities for many individuals and families.
The most common and effective tax planning strategies include:
- Contribute a 401(k) or IRA: The money people put into their 401(k) or IRA the IRS does not tax until it’s withdrawn. Many employers offer a 401(k) option with a matching contribution to help boost their employees’ retirement funds.
- Revise W-4 withholdings: Most people have their income tax withholdings set to a standard amount for their tax bracket. Every financial situation is unique. Therefore, consider revising how much money is paid to the IRS to reduce tax liabilities later.
- Use FSAs and HSAs: With flexible spending and health savings accounts, individuals can contribute to a dedicated account for their medical expenses. This money is specifically for medical care, so it is added to an account pre-tax.
Ultimately, investing money into financial tools that offset taxes can be a significant advantage to both long-term investment and tax planning strategies. A tax professional can help determine the best methods for each situation.
Tax Avoidance Methods
Investment strategies are just one solution for tax avoidance. The IRS offers a variety of opportunities for people and businesses to reduce their tax liabilities.
The most practical IRS tax avoidance methods include:
- Itemization: Depending on how much an individual or couple’s expenses are every year, it might be more lucrative to itemize tax deductions. It can be time-consuming and requires diligent recordkeeping, but it’s especially valuable for anyone with mortgages or expensive medical bills.
- Tax credits: A tax credit, which is different from a deduction, gives money back to individuals and families. These credits generally come with stipulations, so a tax professional is often the best option. However, these credits can be worth the investment for people with big tax bills.
- Tax deductions: Tax deductions are another way to reduce tax liabilities. With a deduction, someone’s taxable income gets reduced, which lowers the total amount owed to the IRS. Popular tax deductions include work-related expenses, property, and real estate taxes, and contributions to charity.
Tax avoidance through the IRS can be one of the most critical tools for individuals and families that don’t have access to tax-reducing investment strategies.
Finding a Tax Relief Program That Works
Even with a dedicated approach to tax avoidance, many people still wind up owing the IRS at the end of the year. Moreover, for some families, owing money to the IRS or state creates a severe burden that snowballs over the next year.
There are options for people who are struggling to pay their taxes. To find the right tax relief program, a professional tax firm can help narrow down the right option for each situation.