Tax Avoidance vs Tax Evasion: Understanding the IRS Announcement

In September, the IRS made an important announcement regarding its change in focus for tax audits. While audit rates will remain unchanged for individuals earning less than $400,000 annually, the IRS aims to hold high-income earners accountable for paying their fair share of taxes.

This development raises the question: can taxpayers take advantage of this shift in focus and bend the rules when it comes to their taxes? As law-abiding citizens, we understand the importance of fulfilling our tax obligations. However, it's natural to be curious about the increased scrutiny on others, such as partnerships, corporations, and promoters who are abusing tax laws.

Before considering any questionable actions on your federal tax return, it is crucial to understand the context behind the IRS announcement. Kassi Fetters, a certified financial planner in Anchorage, Alaska, clarifies that the IRS is not implying they will turn a blind eye to tax evasion by less-wealthy taxpayers. Instead, the agency plans to use new funding from the Inflation Reduction Act to address the decline in audits for wealthy taxpayers over the past decade.

While this news may lead some to believe they can engage in tax evasion, it's essential to recognize the distinction between tax avoidance (which is legal) and tax evasion (which is illegal). Colin Walsh, a principal at Baker Tilly, a Chicago-based tax and consulting firm, explains that tax avoidance refers to taking advantage of legally ambiguous areas in tax returns. In certain situations, tax professionals encounter scenarios where the law does not provide a clear answer, leaving room for interpretation.

On the other hand, knowingly providing false information on your tax return crosses a legal boundary. This includes claiming deductions you do not qualify for or substantially underreporting your income.

In summary, while the recent IRS announcement may make some individuals consider bending the rules, it is crucial to remember that tax evasion remains illegal. The distinction between tax avoidance and tax evasion lies in adhering to the law while navigating the gray areas of tax returns. It is always best to consult with tax professionals to ensure compliance with the law and avoid any legal complications.

To Avoid or Not to Avoid: The Perils of Taxation

In the realm of taxation, individuals often wonder whether it is permissible to maximize their deductions and minimize their tax burden. The fear of an audit looms large, but the question remains: would you emerge victorious in such an ordeal?

Tax professional, Fetters, cautions that most taxpayers are not engaging in fraudulent activities when they explore tax avoidance strategies. Instead, they seek clarity on the permissibility of claiming specific deductions. An all too common scenario involves rental properties, where the lines between personal and business use become blurred.

The prudent approach, according to Fetters, involves considering the potential consequences of an audit. Can you substantiate your claims? If not, not only will you owe the taxes originally in question, but also hefty penalties and interest. Nevertheless, the good news is that such situations seldom result in imprisonment.

So, what's the bottom line? The Internal Revenue Service (IRS) isn't encouraging individuals with a yearly income below $400,000 to fabricate their tax returns. However, if there are valid legal grounds to justify tax avoidance measures and if a reasonable legal judgment supports your rationale, then it may be worth considering.

But a word of caution: be fully aware of the risks involved. If you harbor concerns about potential penalties from the IRS, it is advisable to consult with a tax professional. As Walsh, a tax controversy specialist, emphasizes, conversations about risk should occur at the outset of any tax advisory engagement. Many clients mistakenly assume that a certified public accountant's (CPA) signature on their tax return implies immunity from scrutiny on every line item.

By openly discussing tax avoidance issues at the beginning, accountants empower taxpayers to make informed decisions. This allows individuals to gauge the risks involved and weigh the potential benefits against the potential consequences of an audit. As Walsh aptly expresses, this knowledge serves as a safety net, ensuring that an IRS audit does not catch individuals off guard.

More: Do you reside in one of these 13 states? The IRS might prepare your taxes free of charge next year.

Also read: My spouse and I purchased a magnificent lakeside property for $700,000, which is now valued at $1.2 million. Should we sell now to evade capital gains?