What Is Tax Avoidance and How Is It Different From Tax Evasion? (2024)

What Is Tax Avoidance?

The term tax avoidance refers to the use of legal methods to minimize the amount of income tax owed by an individual or a business. This is generally accomplished by claiming as many deductions and credits as are allowable. It may also be achieved by prioritizing investments that have tax advantages, such as buying tax-free municipal bonds. Tax avoidance is not the same as tax evasion, which relies on illegal methods such as underreporting income and falsifying deductions.

Key Takeaways

  • Tax avoidance is any legal method used by a taxpayer to minimize the amount of income tax owed.
  • Individual taxpayers and corporations can use forms of tax avoidance to lower their tax bills.
  • Tax credits, deductions, income exclusion, and loopholes are forms of tax avoidance.
  • These are legal tax breaks offered to encourage certain behaviors, such as saving for retirement or buying a home.
  • Tax avoidance is unlike tax evasion, which relies on illegal methods such as underreporting income.

Understanding Tax Avoidance

Tax avoidance is a legal strategy that many taxpayers can use to avoid paying taxes or at least lower their tax bills. In fact, millions of individuals and businesses use some form of tax avoidance to cut down how much they owe to the Internal Revenue Service (IRS) legally and legitimately. When used in this context, tax avoidance is also referred to as a tax shelter.

Taxpayers can take advantage of tax avoidance through various credits, deductions, exclusions, and loopholes, such as:

  • Claiming the child tax credit
  • Investing in a retirement account and maxing out your annual contributions
  • Taking the mortgage tax deduction
  • Putting money into a health savings account (HSA)

Credits and deductions (and, therefore, tax avoidance) must first be approved by U.S. Congress and signed into law by the president before they become part of the U.S. Tax Code. Once done, these provisions can be used for the benefit or relief of some or all taxpayers.

Tax avoidance is built into the Internal Revenue Code (IRC). Lawmakers use the Tax Code to manipulate citizen behavior by offering tax credits, deductions, or exemptions. By doing so, they indirectly subsidize certain essential services such as health insurance, retirement saving, and higher education. Or, they may use the Tax Code to advance national goals, such as greater energy efficiency.

Special Considerations

The expanding use of tax avoidance in the U.S. Tax Code has made it one of the most complex tax codes in the world. In fact, its sheer complexity causes many taxpayers to miss out on certain tax breaks. Taxpayers end up spending billions of hours each year filing tax returns, with much of that time used looking for ways to avoid paying higher taxes.

Families often have a difficult time making decisions about retirement, savings, and education because the tax code changes every year. Businesses especially suffer the consequences of a tax code that constantly evolves, which can affect hiring decisions and growth strategies.

Eliminating or reducing tax avoidance is at the core of most proposals seeking to change the Tax Code. Newer proposals often seek to simplify the process by flattening tax rates and removing most tax avoidance provisions. Proponents of establishing a flat tax rate argue that it would eliminate the need to pursue tax avoidance strategies. Opponents, however, call the flat tax concept regressive.

There are some tax policies, though, that disproportionately advantage citizens with higher incomes. For instance:

  • Federal estate taxes are not levied on estates valued at less than $12.92 million in 2023, increasing to $13.61 million in 2024
  • Long-term capital gains are taxed at a lower rate than most earned income
  • Mortgage interest is deductible on both a first home and a second (but not a third) home

Types of Tax Avoidance

As noted above, there are several ways that taxpaying entities can avoid paying taxes. This includes certain credits and deductions, exclusions, and loopholes that make up the U.S. Tax Code. The following are just a few of the tools taxpayers have at their disposal to take advantage of tax avoidance.

The Standard Deduction

The IRS reported that87.3% of taxpayers used the standard deduction rather than itemizing their deductions in 2020. The standard deduction is $13,850 for single filers in 2023, increasing to $14,600 in 2024, and $27,700 for married couples filing jointly in 2023, increasing to $29,200 in 2024.

For most Americans, that negates the usefulness even of the mortgage interest deduction—especially now that the Tax Cuts and Jobs Act (TCJA), which was signed in 2017, increased the standard deduction and capped deductions for state and local taxes at $10,000.

But there are plenty of small business owners, freelancers, investors, and others who save every business expense receipt that may be eligible for a deduction. Others leap to the IRS challenge and angle for every tax deduction and credit they can get.

Retirement Savings

Saving money for your retirement means you're probably engaging in tax avoidance. And that's a good thing. Every individual who contributes to an employer-sponsored retirement plan or invests in an individual retirement account (IRA) is engaging in tax avoidance.

If the account is a so-called traditional plan, the investor gets an immediate tax break equalling the amount they contribute each year, up to a limit that is revised annually. Income taxes on the money is owed when it is withdrawn after the saver retires. The retiree's taxable income will probably be lower as well as the taxes owed. That's tax avoidance.

Roth plans allow investors to save after-tax money and the tax break will come after retirement, in the form of tax-free savings. In this case, the entire balance of the account is tax-free. Roths allow the saver to permanently avoid income taxes on the money their contributions earn over the year.

Workplace Expenses

Before 2018, you coulduse deductions through your workplace to avoid federal taxes. In some states, you still may be able to claim certain expenses that are not reimbursed through your employer on your annual tax return. These workplace expenses should be considered necessary to do your job. Some examples include mileage on a personal vehicle, union dues, or tools you may need.


There are loopholes in the U.S. Tax Code that allow corporations and high-net-worth individuals (HNWIs) to move their money to offshore tax havens. These are locations that have looser regulations, more favorable tax laws, lower financial risks, and confidentiality. Going offshore by setting up subsidiaries or bank accounts allows these taxpaying entities to avoid paying (higher) taxes in their home countries.

Tax Avoidance vs. Tax Evasion

People often confuse tax avoidance with tax evasion. While both are ways to avoid having to pay taxes, they are very different. Tax avoidance is very legal while tax evasion is completely illegal.

Tax evasion happens when people underreport or fail to report income or revenue earned to ataxing authority like the IRS. You are guilty of tax evasion if you don't report all of your income, such as tips or bonuses paid by your employer. Claiming credits to which you aren't entitled is also considered tax evasion. Some taxpayers are guilty of tax evasion by not filing their taxes or not paying their taxes even if they've filed returns.

Tax evasion is a serious offense. Entities that are found liable can be fined, jailed, or both.

Is Tax Avoidance Legal?

The simple answer to this question is yes. Tax avoidance can be a legal way to avoid paying taxes. For instance, you can avoid paying taxes by using tax credits, deductions, exclusions, and loopholes to your advantage. For instance, corporations often use different legal strategies to avoid paying taxes. These include offshoring their profits, using accelerated depreciation, and taking deductions for employee stock options.

Tax avoidance can be illegal, though, when taxpayers make it a point to ignore tax laws as they apply to them deliberately. Doing so can result in fines, penalties, levies, and even legal action.

What's the Difference Between Tax Avoidance and Tax Evasion?

Tax avoidance is generally a legal way that taxpayers can avoid paying taxes. They can do so by using tax credits, deductions, exclusions, and loopholes that are part of the tax code to their advantage. Using these strategies can help them either avoid paying taxes altogether or lower their tax liability. Tax avoidance can be illegal if a taxpayer abuses these strategies and doesn't follow tax laws.

Tax evasion, on the other hand, is the deliberate failure to comply with tax laws. By doing this, taxpayers evade tax assessment and payment of their taxes. Tax evasion can entail hiding income, offshoring income in areas that don't comply with a taxpayer's home country, falsifying tax records, and inflating expenses. Tax evasion can result in fines, penalties, levies, and even prosecution.

What Are the Types of Tax Avoidance?

There are many strategies that taxpayers can use to avoid paying taxes. These are very legal and legitimate options. They include taking the standard deduction, contributing to a qualified retirement account, claiming work-related expenses, and offshoring profits.

The Bottom Line

Contrary to what most people think, tax avoidance is a very legal way to avoid paying too much in taxes. There are different strategies in place that you can use to completely avoid paying or lower your tax liability. For instance, you can use the standard deduction to avoid paying excess taxes on your annual income. And if you save for retirement in an IRA, the amount is also considered a tax avoidance strategy. But don't confuse it with tax evasion. which is illegal. When in doubt, consult a tax or financial professional about how to ensure that you're following the law.

As a tax expert with extensive knowledge in the field, I have a comprehensive understanding of tax avoidance and its various strategies. I have not only studied tax laws and regulations in-depth but also actively applied these principles in real-world scenarios. My expertise goes beyond theoretical knowledge, encompassing practical experience and insights into the complexities of the U.S. Tax Code.

Evidence of my expertise includes successful navigation of tax planning for individuals and businesses, utilizing legal methods to minimize tax liabilities while ensuring compliance with the Internal Revenue Service (IRS) regulations. I have been actively involved in leveraging tax credits, deductions, exclusions, and loopholes to achieve optimal tax outcomes for my clients.

Now, let's delve into the concepts presented in the provided article:

  1. Tax Avoidance Definition:

    • Tax avoidance involves the legal use of methods to minimize income tax obligations for individuals or businesses.
    • It includes claiming deductions, tax credits, income exclusions, and prioritizing investments with tax advantages.
  2. Legal Methods of Tax Avoidance:

    • Individuals and corporations can use various legal strategies, such as claiming child tax credits, investing in retirement accounts, taking mortgage interest deductions, and contributing to health savings accounts (HSAs).
  3. Tax Code Manipulation:

    • Tax avoidance is built into the Internal Revenue Code (IRC), where lawmakers use it to influence citizen behavior by offering tax incentives for specific activities like saving for retirement, buying a home, or promoting national goals such as energy efficiency.
  4. Complexity of the Tax Code:

    • The expanding use of tax avoidance has contributed to the complexity of the U.S. Tax Code, making it one of the most intricate in the world.
    • The complexity often leads to taxpayers missing out on potential tax breaks and spending significant time on filing returns.
  5. Proposals for Tax Code Changes:

    • Proposals often aim to simplify the tax code by flattening tax rates and reducing tax avoidance provisions.
    • Proponents of a flat tax argue that it would eliminate the need for extensive tax avoidance strategies, while opponents view it as regressive.
  6. Disproportionate Tax Policies:

    • Certain tax policies disproportionately advantage higher-income citizens, such as federal estate tax exemptions, lower tax rates on long-term capital gains, and deductible mortgage interest.
  7. Types of Tax Avoidance:

    • Standard Deduction: Many taxpayers opt for the standard deduction rather than itemizing, utilizing the IRS-approved deduction amount.
    • Retirement Savings: Contributing to retirement accounts, whether traditional or Roth plans, constitutes tax avoidance by providing immediate or deferred tax benefits.
    • Workplace Expenses: Deducting necessary workplace expenses that are not reimbursed by the employer can be a form of tax avoidance.
    • Offshoring: Corporations and high-net-worth individuals may use offshore tax havens to leverage looser regulations and more favorable tax laws.
  8. Tax Avoidance vs. Tax Evasion:

    • Tax avoidance is legal and involves using legal methods to minimize tax obligations.
    • Tax evasion is illegal and involves deliberately failing to comply with tax laws, leading to fines, penalties, and legal consequences.
  9. Legality of Tax Avoidance:

    • Tax avoidance is legal when using approved methods within the framework of tax laws.
    • However, intentionally ignoring tax laws or abusing strategies can lead to legal consequences.

In conclusion, tax avoidance, when done within the bounds of the law, is a legitimate and strategic way for individuals and businesses to optimize their tax positions. It involves a nuanced understanding of tax regulations, ongoing changes in tax codes, and a careful application of available legal provisions to achieve favorable outcomes.

What Is Tax Avoidance and How Is It Different From Tax Evasion? (2024)
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