Tax avoidance is a legal way to limit taxable income. The IRS defines avoidance as any action that mitigates tax liability and increases post-tax income.
Evasion, on the other hand, is illegal. You must report any activities that generate income to the IRS. Failure to do so is tax evasion.
Tax avoidance reduces taxable income
The United States government encourages tax avoidance through tax-deductible donations and retirement accounts like 401(k)s. Besides donations, there are other ways to deduct from your taxable income, some of which may surprise you. Expenses such as daycare, tuition and sales tax might count toward your deductions. However, always consult a tax professional before assuming anything is a deductible expense.
Tax evasion conceals taxable income
Similarly, you might commit tax evasion without knowing it. For example, paying anyone for services counts as a wage. Many people hire maids and other workers without realizing they need a W-2. Consult Publication 926 to learn whether you employ a household employee.
Watch out for these forms of income
Governments are cracking down on cryptocurrencies. If you earned capital gains on digital currencies, you must declare them on your tax return.
Overseas income also does not preclude you from paying taxes. The U.S. counts every earning you make regardless of where it resides. Additionally, if you live outside the country, the United States collects taxes if you are a citizen.
The line between tax evasion and avoidance is not always clear. Tax evasion tends to involve cash payments and illegal activities. Tax avoidance is easy to recognize because you still report your total income to the IRS.