What are the Penalties for Tax Avoidance?

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There are no penalties for tax avoidance — unless you get it wrong. Here’s how much you can expect to owe if your tax strategy doesn’t work.

Are there penalties for tax avoidance?

There are no penalties for tax avoidance. That’s because tax avoidance is 100% legal.

Tax avoidance is when you look for ways to maximize your deductions and make other tax planning moves to minimize your taxes. Honestly reporting the facts of your situation and using the law to your advantage is perfectly OK.

Tax avoidance is something that everyone should do.

If you though tax avoidance was bad, you might be thinking of tax evasion. Tax evasion is when you illegally avoid taxes by not reporting income or overstating your deductions.

What happens if you get tax avoidance wrong?

If you get tax avoidance wrong, you might have to pay back taxes plus interest and penalties. This isn’t because you tried tax avoidance but because you filed your taxes incorrectly.

A common example of tax avoidance gone wrong is when independent contractors hear they can deduct their business mileage. They start tracking all of their miles but often don’t realize trips to and from their home are usually a nondeductible commuting expense. So they end up owing extra taxes because their mileage deduction was too big.

Making a mistake in tax avoidance is technically illegal but usually not a big deal. It’s more of a parking ticket than a penalty. You’ll owe extra money, but that’s usually the end of it.

The IRS usually only gets nasty when you keep making the same mistakes, don’t make a reasonable effort to file your taxes correctly, or commit tax fraud.

What are the penalties for getting tax avoidance wrong?

The typical penalty for not filing a correct return and owing more in taxes is:

  • Paying the taxes you owe
  • Paying interest from the due date of your tax return until you pay
  • Paying a late payment penalty of 0.5% per month.

If your mistake makes you understate the tax you owe (not your income) by the greater of 10% or $5,000, you may have to pay an additional accuracy penalty. The penalty is 20% of the additional tax you owe.

The IRS may also impose the accuracy-related penalty if they find you negligently or intentionally didn’t follow the tax rules and regulations. This includes things like not keeping proof of your deductions or not reporting income that you got a 1099 for.

Will the IRS audit you if you try tax avoidance?

The IRS keeps how it chooses people for audit a secret. They don’t want people trying to game the system.

What we do know is that they randomly select people for audits. Your chances of being selected go up the more money you make and the more complicated your tax return is. They also take a closer look at deductions or credits that are often abused like the Earned Income Tax Credit.

The IRS may also audit you if it notices an error or discrepancy in your tax return.

So, no, tax avoidance doesn’t guarantee an audit. Yes, certain tax moves do have a higher chance of an audit. But, if you do your taxes properly and keep the proof, all an audit is is you showing the IRS your proof so they go away.

Do you need a tax attorney or a tax accountant for tax avoidance?

It really depends on what you’re trying to do. If you have a salaried job and are only taking personal deductions, like your mortgage interest, child tax credit, and charitable contributions, you can probably just use tax filing software.

Giant corporations hire armies of tax experts to help them use every single loophole. If you’re a small business or high-net-worth individual, it can depend on how complicated your tax situation is and how much you know about taxes.

If you’re not sure what tax avoidance moves might be available in your situation, it doesn’t hurt to schedule a consultation with a tax professional to find out.

Thanks for reading.

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