What is Tax Avoidance?
Definition: Tax avoidance is where an individual or company uses avenues that allow them to pay less tax than they would otherwise be obligated to pay.
There is a wise saying that death and taxes are one of the only things that are certain in life and that is somehow true for the most part. Taxes are a natural part of an economy and they are also important because they allow the government to allocate resources and also to facilitate development. That is why paying taxes are usually enforced by the law for both individuals and corporate.
The good thing is that it can be done in a legal way by leveraging credits and permissible deductions. Tax avoidance is not actually a tool for individuals and businesses to avoid paying taxes but it is rather aimed at legally minimizing the amount of taxes that businesses or individuals would be required to pay.
How to Avoid Taxes
There are various methods used for tax avoidance based on the existing tax codes of every country. A business can take advantage of tax shelters to protect its income from being taxed too heavily. It can do this by creating employee retirement plans and one of the most common ways of tax avoidance is to use tax havens.
Businesses can take advantage of legal tax deductions so that they can reduce their expenses, thus minimizing the business tax that they are required to pay. Businesses can also legally defer its taxes and this allows them to push back their taxes so that they can pay them later. This is a good idea for a business that wants to first solidify its growth and it can be done through a 401(k) plan, SEP-IRA and even IRA.
Firms or businesses can also use tax credits which will allow them to use money for legal purposes. For example, there are work-related tax credits which is basically a tax credit provided to businesses for providing job opportunities. Tax avoidance therefore involves taking advantage of a tax loophole. The latter is defined as a technicality which businesses and individuals can exploit so that they can reduce their tax obligation without breaking the law.
Tax Avoidance vs Tax Evasion – What’s the Difference?
The first major difference between the two is that tax avoidance is generally accepted within legal limits but tax evasion is completely outlawed and punishable by law. Tax avoidance happens when individuals take advantage of loopholes in the system so that they can reduce their tax obligation.
Tax evasion is where businesses or individuals under-report their revenues or where they avoid reporting their revenues altogether. Note that tax evasion is punishable by law and one can even serve jail time.
The Internal Revenue Code Encourages Tax Avoidance
As noted earlier, even the law is soft on tax avoidance are good reasons why it is supported by the Internal Revenue Code. For example, the employment tax benefits are put in place to create an incentive for businesses to hire employees. Job creation allows for more people to have a taxable salary so either way, it benefits the tax man further down the road. The Internal Revenue Code is tuned to manipulate taxpayer behavior.
The tax code provides various credits and deductions especially those that are targeted towards helping taxpayers improve some aspects of their lives. For example, there are tax deductibles that encourage taxpayers to invest, to take out insurance coverage. The government also encourages tax benefits that encourage people to join retirement plans so that they will be self-sufficient even in retirement. This approach aims to help people become more financially independent in their retirement so that they do not have to rely on family, friends or the government for upkeep.
One good example of how the tax code encourages tax avoidance is by charging low capital gains tax rates. This move is aimed at encouraging investment which in turn helps to create jobs and thus improving the livelihoods of more people. Some tax reliefs such as interest deductions are designed to encourage homeownership.