The difference between tax optimization and tax fraud is that the first is legal, and the second is a crime. However, every taxpayer needs to understand the subtle differences between the two. This can help them avoid crossing the line, which can leave them vulnerable to the consequences of tax fraud.
In most cases, wage earners cannot leave themselves open to much scrutiny. However, for business owners there are more ways to avoid paying taxes, either legally or illegally.
Tax optimization or tax fraud?
Tax practitioners agree that tax law often lacks clarity, making it difficult for the IRS to prove that the law was intentionally violated. Proof of intentional tax indiscretion is required by the law for criminal prosecution. As the Tax Executive points out in their article Tax Avoidance vs. Tax Evasion, in a U.S. Supreme Court decision about a decade ago, a taxpayer can avoid or decrease tax payments in a way the law permits. The decision also points out they have the right not to be doubted.
However, if intentional tax evasion can be proved by the IRS, then it constitutes a criminal felony charge. If the person believes that they acted consistently with the law, they may still face civil charges.
Common tax law violations
Several tax law violations constitute tax fraud. These include:
- Omitting income by intentionally hiding portions of it.
- False entries in financial statements, and keeping two sets of books.
- Claiming inflated or false deductions for travel expenses, charities, etc.
- Concealing assets and income.
- Personal expenses that are intentionally claimed as business expenses.
- Avoiding tax by labeling transactions differently. One example: corporations might label “dividends” or other payments as interest.
Strategies for tax optimization
Tax optimization can be reached with a clear tax strategy that plans the structure of transactions to obtain low tax rates. The tax planning strategy requires careful preparation to minimize taxable income, maximize credits and deductions, and control their timing. Tax planning and optimization are both done before tax liability to ensure that they don’t violate any tax rules. It uses the law to ensure tax efficiency and keep everything legal.
Methods that can be used for tax optimization include:
- Tax deductions aimed at decreasing business expenses and the tax owed
- Using a tax deferral plan to delay tax payments
- Using tax credits like business purchases and benefits to employees
- Establishing employee retirement plans to shelter revenue.
The purpose of tax optimization is to ensure tax efficiency. It uses the provisions in the law to relieve tax liability. If tax optimization is to be efficient, then a good knowledge of the tax laws and reduction methods is essential.
Tax regulations do change quite often, and it’s usually very hard for most people to keep up with these. Tax optimization should be reached with the help of a professional accountant or tax expert. These professionals know how to apply the law and minimize the tax burden optimally.
Maintaining best tax practices requires that any transactions that may have significant tax consequences should avoid possible IRS scrutiny. These should be accompanied by all the documentation to support them. Sound tax planning constitutes the wisdom of solving problems before they need prevention.