What is Tax Avoidance?
Definition: Tax avoidance is the reduction of the tax amount payable by taking advantage of the applicable laws. It is a legal method of reducing your taxes.
What does Tax Avoidance mean?
Taxpayers can reduce their tax liability by claiming the deductions and credits that are allowed.
It’s important to know that the Internal Revenue Code contains many provisions that permit taxpayers to lower their taxable income. Why does it do that? These provisions encourage individuals to invest for their retirement, allocate funds for health insurance, or take educational loans. The government uses tax credits to influence the manner in which people spend their money.
Similarly, businesses are offered tax credits too. Deductions are available for using renewable energy, allocating funds to research activities, and various other activities that the government wants to promote. Corporations and small businesses are incentivized to deploy money in these areas by the tax credits that are available.
Remember that there is a big difference between tax avoidance and tax evasion. Tax avoidance is permitted, even encouraged. But tax evasion is illegal. The IRS refers to it as “illegal tax avoidance.” Tax evasion could take place in the form of suppressing revenue, claiming false deductions, or making other false entries in the books.
Example of Tax Avoidance
Here are some examples of tax avoidance:
⇨ Money that is allocated to a 401(k) account allows you to reduce your taxes.
⇨ Buying a life insurance policy. The amount that the life insurance company pays could be exempt from taxes.
⇨ Purchasing fixed assets for your business. By doing this, you can claim a higher amount in depreciation credits.
Tax avoidance is a legal method of lowering your tax liability. It should not be confused with tax evasion, which is considered to be a crime.