What is Tax Avoidance?

Tax avoidance is the legal effort of taxpayers to pay the minimum amount of taxes possible. Tax avoidance is sometimes confused with tax evasion, which is illegal. Tax evasion also involves minimizing taxes, but the method violates the law.

Tax avoidance is commonly practiced

It's possible that some people are practicing tax avoidance without even realizing it. If you work for a company and put some of your earnings in a 401K plan, you are doing more than providing for future income. That 401K deduction reduces the amount of your current income, lowering the amount of taxes you pay that year. Eventually, the income in your 401K will be taxed, but you have avoided paying taxes on it currently by deciding not to take that money as salary. Another example is the pre-tax deduction allowed for health care expenses. An employee can designate a certain amount of salary (within a set yearly limit) to go into a fund to pay for qualified health care expenses. Because the government has a system that allows those health care expenses to be paid out of pre-tax dollars that is an example of tax avoidance. If you had taken that money as salary instead, you would have received less because of taxes.

Good tax planning includes tax avoidance

It makes sense to seek a tax professional with experience in tax avoidance. For example, a tax expert may be able to reduce the amount of income with investments, deductions and other methods so that a taxpayer falls below another tax bracket. The percentage of taxes that must be paid to the government is determined by the amount of income. Each level of income is a bracket, and as taxpayers reach higher brackets, they pay more taxes. Conversely, if tax avoidance can reduce income to a lower tax bracket, that means a lower tax bill.

Common examples of tax avoidance

In addition to the 401K example, which is commonly offered at many medium and large companies in the country, there are a number of other tax avoidance plans that are routinely used. One involves creating a profitable small business at home that can take advantage of additional potential tax deductions. For example, a person may use a portion of their home as a photography studio. While a variety of IRS rules must be followed, it is generally possible to make business deductions based on the portion of the home used for an ongoing, profitable side business. Potential deductions include the property taxes and utility costs of that portion of the home that is used more than 50 percent of the time as a business. As with all tax avoidance methods, be certain to confer with a tax professional to make sure that all methods of reducing tax liability are within the letter and spirit of the law.