Tax avoidance is a process by which a person plans his or her finances to get exemptions and deductions in tax provided by tax laws for reducing tax liability. On the other hand, tax evasion is an attempt to lower the tax liability by fraud or active concealment. It is a criminal act which invites penalty.
In tax avoidance an individual legally utilizes the tax regime for his own advantage to reduce the tax liability by means which are not outside the law. An individual plans in a way so that all exemptions and deductions provided by the tax laws to reduce taxable income apply to him or her.
Most taxpayers take the help of some form of tax avoidance. People contribute to employer-sponsored retirement plans for the purpose of tax avoidance as the amount of taxes paid on the funds at the time of withdrawal is generally less than the amount which the individual owes today. Moreover, retirement plans gives the scope to the taxpayers to defer paying taxes allowing their savings to grow at a faster rate.
The term tax planning is a synonym for tax avoidance. It is used by tax advisors as a better alternative of ‘tax avoidance’. It is also used in the tax regulations to differentiate tax evasion from tax avoidance which passes through the loopholes in the law.
Tax evasion involves failing to report proper income, or claiming authorized deductions. Some instances of tax evasion include acts like when a contractor “fails” to report the Rs. 100, 000/- cash received by him for constructing a house, or when the owner of a business claims to deduct Rs. 200, 000 towards personal expenses from his business taxes, or when someone falsely claims deductions for donations to charitable institutions.
Likewise, if a property is worth Rs. 30,00,000/- and the owner files an incorrect tax return, improperly stating the value of the property and claiming the property is only worth Rs. 10,00,000/-, thus owing less amount of taxes, he is guilty of evading taxes.
Tax evasion is an act found in the underground economy. The extent of tax evasion is measured in the amount of undeclared income, the difference between the actual amount of income to be reported to the tax authorities and the actual amount which is declared.
People attempting not to pay taxes think that they have interpreted the law that tells that they are not subject to being taxed. These people are sometimes known as tax protesters. They openly try to evade tax and at times are subjected to penalty, whereas a successful one avoids tax. Tax evasion is a crime in most of the countries and the guilty person has to pay fine and/or is subjected to imprisonment.