The Difference Between Aggressive Tax Minimization & Abusive Tax Avoidance
- Not paying your tax in full can lead to substantial penalties from the IRS. If you embark upon a program of aggressive tax minimization, the IRS may question some of your deductions and ultimately render them unusable. In cases like this, the IRS generally assesses either a negligence penalty or a substantial understatement-of-tax penalty, both of which are 20 percent of the amount of tax you owe. Additionally, the IRS will charge interest on the amount you did not pay that you owed, plus penalties of 0.5 percent for each month you have not paid the tax you owe. However, if you fraudulently abuse the tax system, the IRS can assess anything from a 75 percent civil fraud penalty to jail time and fines.
- Aggressive tax minimization involves interpreting the tax code in a way that provides the most tax benefit while still keeping you in compliance with tax laws. These strategies are legal but are considered aggressive because they tend to draw IRS scrutiny, which can lead to a tax audit and possible penalties if the IRS disagrees with the validity of the strategy. For example, if you take a personal trip that also involves business, you may categorize a certain percentage of your expenses on that trip as deductible business expenses. However, the IRS may question the amount of business you did on the trip and whether you took an appropriate or excessive amount of deductions. If your expenses are legitimate, however, do not shy away from using the deductions to which you are entitled, even if the IRS does take a closer look at your return.
- Rather than aggressively classifying expenses to maximize tax deductions, abusive tax avoidance is a willful manipulation of the tax code to obtain a fraudulent benefit. For example, if you take deductions for dependents you do not have or invent business expenses out of thin air for the purpose of reducing taxes, you are fraudulently abusing the tax code. Some taxpayers take this chance because the IRS cannot audit every tax return. However, if the IRS discovers your fraud, you will be assessed significant additional penalties and may be headed to prison for as long as five years.
- Sometimes, the line between tax avoidance and tax evasion can be slim. If you are unclear about the interpretation of tax law, it is usually better to err on the side of caution, since the penalties are so steep. You can also enlist the aid of a certified tax accountant to help you know where the IRS typically draws the line on tax matters.
