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Small Businesses: Don’t Confuse Tax Avoidance with Tax Evasion

September 3, 2019
Small Business

As much as you don’t like the idea of paying taxes, you have to pay them. It is crucial for businesses to run smooth operational activities throughout tax-year. However, small businesses often confuse the applicability of ‘tax avoidance’ and ‘tax evasion’.

The terminology may sound similar, but the concept is largely different. In hindsight, there are no legal percussions for tax avoidance. Intentional tax evasion, on the other hand, can make you liable for hefty penalties and even criminal charges.

It is vital to take into account that tax avoidance is not something you can do on your own terms. Instead, it refers to when you seek the assistance of a tax specialist to get an in-depth insight on possible tax avoidance methods without trapping yourself in a cobweb of illegal entanglements.

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Lawful Technical Description

Tax avoidance is practically the minimization of taxes. You find legal loopholes to get tax deductions set forth by the IRS and set deferral plans to take advantage of the total tax credits.

Tax evasion is defined as the deliberate unwillingness to not pay taxes. Usually, tax evaders procrastinate when it comes to reporting business taxes and often do not report the total income at all. Furthermore, not paying taxes intentionally for the amount you owe also classifies as tax evasion.

Major Differences between Tax Avoidance and Tax Evasion

Tax Avoidance

As stated above, tax avoidance strictly refers to the inclination to avoid taxes through legal tax code. Business owners frequently use tax shields to plan viable strategies and protect income from taxes.  Tax deductions, for instances, are one of the many ways for small businesses to decrease business expenses.

You can set up a SEP-IRA or 401(k) deferral plan to setback the date of your taxes at a reasonable time. Additionally, if you are investing extra capital in your business activities, take advantage of the tax credits such as Work Opportunity Tax Credit (WOTC) to structure the cost-benefit ratio of hiring employees.

Tax Evasion

The illegal practice of evading your taxes means not paying owed taxes. Furthermore, reporting faux income is deemed as tax evasion. As for fraud, think of it as a sub-section of the tax evasion. It practically means intentional attempt to swindle or misrepresent your tax information to the IRS.

Tax fraud cases are handled by the IRS Criminal Investigation Unit. Tax evasion is not necessarily associated with your income taxes, but sales taxes and employment taxes as well. Trust fund taxes, for example, are one of the most common tax evasive strategies caught by the IRS. Failure to pay sales taxes or employment taxes to the federal authorities can result in heavy penalties. So long as you owe a certain amount of tax payments, there is a plausible cause of tax evasion.

Moreover, consciously under reporting your business income, not mentioning the source, knowingly underpaying taxes, overstating expenses, or falsifying payroll slips to the IRs falls under tax evasion.

Also, there is no such thing as a free hand when it comes to deductions. Consequently, claiming false deductions would land you as a tax evader. The same rules are put in place for maintaining two books, not disclosing your assets, and transferring your income to an unauthorized financial portal.

What about Tax ‘Loophole’?

Tax loophole identifies as the indirect violation of the law. However, a loophole such as accelerated depreciation often renders tax complexities. The idea is to partake in tax benefits without breaking the lax. What’s the solution? Focus on the grey areas that may be interchangeable. And this is where an unbiased and unprejudiced tax specialist comes in handy to help you get out of the tax swamp.

Is Employment Tax Evasion Different?

Withholding or not reporting employees’ payroll records is a major tax evasion issue. Similarly, small businesses often hire uncategorized payroll services from an outside source that should be reported. The lower managerial staff of your business may want the cash payment, which also needs to be accounted to the IRS.

Accidental Tax Evasion

The negligence is not viewed as tax fraud or evasion. If you mistakenly reported an underpayment or nonpayment of taxes, you may have some wiggle room to rectify the past mistake and provide a rational explanation to the federal authorities. However, unconvincing or mathematically unreliable story would result in 20% penalty on the tax payment amount.

Avoidance of Tax Charges

You don’t have to mindlessly beat around the bush at every tax opportunity. The more knowledgeable you are about tax laws, the safer you’ll be to avoid foreseeable tax charges. Also, find out the legal status of each deduction in your state and what bookkeeping methods you should adopt to avoid an audit from the IRS.

Employers should be thoroughly well-versed when it comes to different payments requirements and criteria for payroll taxes to avert tax headache. The magic lies in your openness and objectivity to heed the advice of your tax professional who can help you prepare and classify the income and expenses accounts.

Consequences of Tax Evasion

Your tax evasion case is either reviewed in a court of law or by IRS criminal division to proceed with the prosecution. Remember, that your non-guilty stature doesn’t mean you wouldn’t have to pay for the invested time and money incurred on the case.

The criminal charges on tax evasion can convict you as a criminal. And if you fail to pay penalties, the jail time could be extended from the original prison sentence of five (5) years. The felony is liable only when there’s proven evidence of willful evasion or cheating any form of tax.

Conclusion: Come Out Clean

Whether you want to acquire the services of a tax expert or get instant information from tax software, adhere to all legal options to avoid taxes. However, it all comes down to knowing certain grey areas that the IRS does not compromise.

Make the most out of Form 1040x that grants you the ability to make a few changes in your previously filed tax returns. You should, however, take into consideration the inevitability of mistakes from bookkeepers and show remorse as an emotional response to the IRS authorities to get off the hook. Halon Private Client can make sure you are always compliant. We can even check your bookkeeping quarterly to make sure there are no IRS red flags.

Tatiana Bashlova

Tatiana is the Junior Vice President at Halon. She has experience in operations, payroll, legal, human resources, and finance in various industries. In her spare time she enjoys reading about new laws, hiking, and fishing. .

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