Adam Eric Junkroski
NOTE: Nothing in this blog should be relied upon for legal advice or counsel. Always consult a licensed attorney for questions of the law.
Some of the most frightening ground for any tax practitioner to tread is ground that’s uncertain. Yes, there are places in tax where approximations and estimations play a part, but overall, it’s a fairly precise area of work. For both the practitioner and the client, mistakes can carry serious repercussions, so precision is warranted.
A practitioner’s responsibility is always first to the law and ethical guidance, second to the client. That means using the law to the client’s advantage where possible to reduce tax. But sometimes the law itself can be confusing, complex, or unclear, resulting in a situation where practitioners can’t be 100% confident they are avoiding, rather than evading tax.
What is Tax Avoidance?
Methods which minimize tax liability while observing current law constitute tax avoidance, and are by definition legal. Tax avoidance can involve use of deductions, tax incentives, credits, and other authorized actions or programs sanctioned or provided for by law. Additionally, there are sometimes loopholes in tax law that can be advantageous for a taxpayer. Taking advantage of legal loopholes is acceptable, but can enter some gray area we’ll get to in a bit.
What is Tax Evasion?
In contrast, tax evasion willfully and unlawfully evades or avoids paying taxes by intentionally misrepresenting or concealing income, assets, transactions, or other relevant information to reduce tax liability. Tax evasion is a very serious criminal offense and can result in severe penalties, including fines, interest, and imprisonment. Some common examples of tax evasion include:
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Underreporting or omitting income
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Claiming personal expenses as business expenses, or miscategorization of any transaction for the purpose of evading tax
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Claiming dependents you aren’t legally entitled to claim, or making one up
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Inventing or overstating tax deductions
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Claiming credits you don’t qualify for
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Keeping two sets of books for a business
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Transferring assets to others specifically to avoid paying tax
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Hiding income or assets
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Holding property under a name other than your own
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Not reporting or hiding income sources
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Destroying tax records
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Filing a false tax return
Where are some of the gray areas?
Tax practitioners should always be familiar with the line between avoidance and evasion, but tax law changes and complexity in existing law can make some situations harder to judge than others. Some examples include:
While there are many more examples where a practitioner might find themselves uncertain, these represent some of the more common areas.
Everyone makes missstakes
Just the words “fees” and ”penalties” are enough to make most people’s blood run cold, but when you start mentioning “imprisonment” or “loss of social security benefits,” or “loss of your passport,” folks can get positively freaked.
The good news is that awareness does play a part. While it isn’t the ENTIRE difference between tax evasion and tax avoidance, prosecution of tax evasion cases does require the affirmation of three elements:
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A substantial tax deficiency exists.
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The accused made an affirmative attempt to evade or defeat the assessment or payment of income tax.
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The accused acted willfully.
That third condition is one of the keys. Willfulness is complicated to prove, but it can definitely be done (and has been). Simply put, it’s the condition of a filer knowing what their tax obligations were, but choosing not to comply.
When tax evasion exists, but willfulness does not, the taxpayer will still owe penalties and fees on top of the unpaid burden, but all of the criminal implications disappear. Here’s the catch — if the taxpayer is made aware of the initial error and fails to correct it before the IRS sees it, it can become willful. So self-reporting is the smart thing to do.
How can I protect myself and my client?
We’re going to go out on a limb and assume you don’t represent Al Capone. In the vast majority of cases, tax evasion activity results from error or ignorance rather than intent. But it can still cost both you and your client plenty. Here are best practices you should already follow:
Clean books make happy taxes
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