# Tax Avoidance vs. Evasion: Legal Strategies and Key Differences

## What Is Tax Avoidance?

Tax avoidance involves using legal strategies to reduce the amount of [income tax](https://www.investopedia.com/terms/i/incometax.asp) owed by individuals or businesses. These strategies include claiming permissible deductions and credits and making investment choices that offer tax advantages, like purchasing tax-free municipal bonds. In stark contrast, [tax evasion](https://www.investopedia.com/terms/t/taxevasion.asp) entails illegal practices, such as underreporting income and falsifying deductions, making it a distinct and unlawful activity.

### Key Takeaways

*   Tax avoidance is a legal practice where taxpayers use provisions in the tax code, such as deductions and credits, to minimize their tax bills.
*   Distinct from tax avoidance, tax evasion is illegal and involves underreporting income or falsifying information to reduce tax liabilities.
*   Strategies like taking the standard deduction, saving for retirement in tax-advantaged accounts, and offshoring profits are common methods of tax avoidance.
*   The complexity of the U.S. tax code means many taxpayers miss out on potential tax breaks, spending significant time navigating the system.
*   While legal, tax avoidance can become illegal if taxpayers intentionally misuse tax laws, which can lead to penalties or prosecution.

![Tax Avoidance: Legal methods used by a taxpayer to minimize the amount of income tax owed.](https://www.investopedia.com/thmb/Sq-yGcUDpJbshksTyoC6vmYC_m0=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/tax_avoidance.asp-Final-9d7e3d82dc5c4ce293256ff9d548494d.png)

*— Investopedia / Dennis Madamba*

## How Does Tax Avoidance Work?

Tax avoidance is a legal way for many taxpayers to lower their tax bills. Millions of individuals and businesses use some form of tax avoidance to legally and legitimately cut down how much they owe the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp). Methods of tax avoidance are also referred to as [tax shelters](https://www.investopedia.com/terms/t/taxshelter.asp) when used in this context.

Taxpayers can use various credits, deductions, and exclusions for tax avoidance, including:

*   Claiming the [Child Tax Credit](https://www.investopedia.com/terms/c/childtaxcredit.asp) and numerous other available tax credits
*   Investing in a retirement account and maxing out annual contributions
*   Claiming the mortgage tax deduction
*   Putting money into a [Health Savings Account (HSA)](https://www.investopedia.com/terms/h/hsa.asp)

Tax credits and deductions must first be approved by the U.S. Congress and signed into law by the president before they can become part of the U.S. Tax Code. These provisions can then be used for the benefit and relief of taxpayers.

Tax avoidance is built into the [Internal Revenue Code (IRC)](https://www.investopedia.com/terms/i/internal-revenue-code.asp). Lawmakers use this Tax Code to manipulate citizen behavior by offering tax credits, deductions, or exemptions. They indirectly subsidize certain essential services such as health insurance, retirement savings, and higher education or they may use the Tax Code to advance national goals such as greater energy efficiency.  

> **Important**
>
> Tax credits work somewhat differently than tax deductions. They're subtracted from what you owe the IRS or other tax authorities after you prepare your tax return and figure out what you owe. Tax deductions are subtracted from your gross income to arrive at your taxable income.

## Complexities and Challenges of Tax Avoidance

Extensive tax avoidance measures have made the U.S. [Tax Code](https://www.investopedia.com/terms/t/tax-code.asp) one of the most complex in the world. This complexity causes many taxpayers to miss certain tax breaks because they don't understand them. Taxpayers end up spending billions of hours each year filing tax returns and much of that time is spent looking for ways to avoid paying higher taxes.

Families often struggle with decisions on retirement, savings, and education due to annual [tax code](https://www.investopedia.com/articles/tax/09/tax-codes-rules-regulations.asp) changes. Businesses especially suffer the consequences of a tax code that frequently evolves and this can affect hiring decisions and growth strategies.

Proposals to the Tax Code often attempt to simplify the process by flattening tax rates and removing many tax avoidance provisions. Proponents of establishing a [flat tax](https://www.investopedia.com/terms/f/flattax.asp) rate argue that it would eliminate the need to pursue tax avoidance strategies but opponents call the flat tax concept [regressive](https://www.investopedia.com/terms/r/regressivetax.asp).

> **Tip**
>
> Make sure you save every receipt that may be useful for legal tax avoidance if you're a business owner, freelancer, or investor.

## Common Strategies for Legal Tax Avoidance

Taxpayers can avoid taxes using credits, deductions, and exclusions in the U.S. Tax Code. These are just a few of the tools that taxpayers have at their disposal to take advantage of tax avoidance.

### The Standard Deduction

The IRS has reported that 87.3% of taxpayers used the [standard deduction](https://www.investopedia.com/terms/s/standarddeduction.asp) rather than itemize their deductions in 2020. The standard deduction is $14,600 for single filers in 2024 and $29,200 for married couples filing jointly.  

The alternative to claiming the standard deduction is to tally up every itemized, tax-deductible expense you paid during the tax year and enter them all on Schedule A of your tax return. You can then claim the total of these deductions instead. But this is only advantageous if the total amount is more than the standard deduction you qualify for. You'd be subtracting less from your taxable income otherwise.

The Tax Code doesn't allow you to claim both the standard deduction and to itemize deductions as well. You must do one or the other.

### Retirement Savings

Saving for retirement often involves tax avoidance. Every individual who contributes to an employer-sponsored retirement plan or invests in an [individual retirement account (IRA)](https://www.investopedia.com/terms/i/ira.asp) is engaging in tax avoidance.

The investor gets an immediate tax break equaling the amount they contribute to a traditional plan each year up to a limit that's updated annually. Income tax on the money isn't owed until it's withdrawn after the saver retires. The retiree's [taxable income](https://www.investopedia.com/terms/t/taxableincome.asp) will be less in the years the contributions, reducing taxes owed. Growth on the money is typically taxed after retirement when withdrawals are made.

Roth plans work differently. There's no immediate tax break for making contributions. They allow investors to save after-tax money so the tax break comes after retirement in the form of tax-free savings. Roth accounts allow the saver to permanently avoid paying income tax on the money their contributions earn over the years, subject to some qualifying rules.

### Offshoring

The U.S. Tax Code allows corporations and [high-net-worth individuals (HNWIs)](https://www.investopedia.com/terms/h/hnwi.asp) to move their money to offshore tax havens. These are locations that have looser regulations, more favorable tax laws, lower financial risks, and confidentiality. Going [offshore](https://www.investopedia.com/terms/o/offshore.asp) by setting up subsidiaries or bank accounts allows taxpaying entities to avoid paying higher taxes in their home countries.  

## Tax Avoidance vs. Tax Evasion

People often confuse tax avoidance (legal) with tax evasion (illegal). Tax evasion involves underreporting or failing to report income to tax authorities like the IRS and is a serious offense, punishable by fines and imprisonment. You're [guilty of tax evasion](https://www.investopedia.com/financial-edge/0110/five-famous-tax-cheats.aspx) if you don't report all your income, such as if you omit tips or [bonuses](https://www.investopedia.com/terms/b/bonus.asp) paid by your employer. Claiming credits to which you aren't entitled is also considered tax evasion. Some taxpayers are guilty of tax evasion by not filing their tax returns or not paying their taxes due even if they've filed returns.

## Is Tax Avoidance Legal?

Tax avoidance can be a legal way to avoid paying taxes. You can accomplish it by claiming tax credits, deductions, and exclusions to your advantage. Corporations often use different legal strategies to avoid paying taxes. They include offshoring their profits, using accelerated depreciation, and taking deductions for employee stock options.

Tax avoidance can be illegal, however, when taxpayers deliberately make it a point to ignore tax laws as they apply to them. Doing so can result in fines, penalties, levies, and even legal action.

## What's the Difference Between Tax Avoidance and Tax Evasion?

Tax avoidance is a legal way for taxpayers to avoid paying taxes. They can do so by using the tax credits, deductions, and exclusions that are part of the tax code to their advantage. Using these strategies can help them either avoid paying taxes altogether or lower their tax liability. Tax avoidance can be illegal if a taxpayer abuses these strategies and doesn't follow tax laws.

Tax evasion is the deliberate failure to comply with tax laws. Taxpayers evade tax assessment and payment of their taxes. Tax evasion can entail hiding income, offshoring income in areas that don't comply with a taxpayer's home country, falsifying tax records, and inflating expenses. Tax evasion can result in fines, penalties, levies, and even prosecution.

## What Are the Types of Tax Avoidance?

Taxpayers can use many strategies to avoid paying taxes and they're legal and legitimate options. They include taking the standard deduction or itemized deductions, contributing to a qualified retirement account, claiming tax credits, and offshoring profits.

## The Bottom Line

Tax avoidance is a very legal way to avoid paying too much in taxes. There are strategies in place that you can use to lower your tax liability. You can use the standard or itemized deductions to avoid paying excess taxes on your annual income. The amount is also considered a tax avoidance strategy if you save for retirement in an IRA or 401(k).

Don't confuse tax avoidance with tax evasion which is illegal. Consult a tax or financial professional about how to ensure that you're following the letter of the law if you're in doubt.

> **Article Sources**
>
> 1.  Intuit Turbo Tax. "[Tax Avoidance, Tax Evasion and Tax Sheltering: How They Differ](https://turbotax.intuit.com/tax-tips/tax-payments/tax-avoidance-tax-evasion-and-tax-sheltering-how-they-differ/L0C16irkA)."
>     
> 2.  U.S. Department of the Treasury. "[Writing and Enacting Tax Legislation](https://web.archive.org/web/20220218053155/https://www.treasury.gov/resource-center/faqs/taxes/pages/writing.aspx)."
>     
> 3.  Internal Revenue Service. “[Credits and Deductions for Individuals](https://www.irs.gov/credits-deductions-for-individuals).”
>     
> 4.  Taxpayer Advocate Service. “[Most Serious Problems: At a Glance](https://www.taxpayeradvocate.irs.gov/wp-content/uploads/2023/01/ARC22_MSP_Glance.pdf).”
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>     
> 7.  Internal Revenue Service. "[Deductions for Individuals: What They Mean and the Difference Between Standard and Itemized Deductions](https://www.irs.gov/newsroom/deductions-for-individuals-what-they-mean-and-the-difference-between-standard-and-itemized-deductions)."
>     
> 8.  Internal Revenue Service. "[Traditional and Roth IRAs](https://www.irs.gov/retirement-plans/traditional-and-roth-iras)."
>     
> 9.  Congressional Research Service. “[Tax Havens: International Tax Avoidance and Evasion](https://crsreports.congress.gov/product/pdf/R/R40623/25).” Pages 1, 12. 
>     
> 10.  Office of the Law Revision Counsel/United States Code. “[26 USC 7201: Attempt To Evade or Defeat Tax](https://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section7201&num=0&edition=prelim).”
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> 11.  Internal Revenue Service. "[Worksheet Solutions: The Difference Between Tax Avoidance and Tax Evasion](https://apps.irs.gov/app/understandingTaxes/whys/thm01/les03/media/ws_ans_thm01_les03.pdf)." Page 1.