Tax avoidance versus tax evasion: can you name the difference? The distinction is absolutely essential and can mean the difference between tax savings and jail time. Tax avoidance is the term used to describe legal strategies for lowering your tax bill by structuring your transactions so that you reap the largest tax benefits. Tax evasion, on the other hand, is an attempt to reduce your tax liability by concealing information or otherwise deceiving the IRS—in other words, committing a tax-related crime.
With ongoing inflation and fluctuating tax laws, taxpayers may find themselves scrambling for ways to lower their tax bill by the end of each year. This can make the uneducated taxpayer especially susceptible to tax schemes making big promises they cannot deliver on. All it takes is an enticing promise on some internet ad: “Eliminate your tax bill with this underused tax credit!” The big question is how can you tell if this is a legitimate tax avoidance strategy or a tax evasion scheme that will get you in trouble with the law?
The most reliable way to evaluate any tax strategy is to work with a Certified Tax Planner. You can also be prepared to assess savings opportunities by learning a few tips from how professionals vet a tax strategy.
ims that they cannot explain exactly how it works because that is “proprietary information,” run the other way.
Overpromising is another common sign of a n real court cases, but a simple read of the actual text will reveal that it doesn’t say what the promoters claim it says!
Key Questions to Ask When Evaluating a Tax Strategy
While some scams may immediately come off as too good to be true, others may be much more subtle. This can be the case with tax credit scams—at first glance, some of the details sound similar to legitimate tax strategies, which can result in significant savings. However, upon further inspection, these red flags will begin to surface. Signs you should be looking for include:
• Secrecy
• Exclusivity
• Overpromising
• Lack of transparency
• Lack of successful history
• Lack of adjudication
The posture of secrecy and exclusivity makes the tax credit sound like an insider opportunity or a secret only the wealthy know about. Now, of course, it is true that there are tax credits that aren’t making news headlines and that high-income individuals and business owners are more likely to know about. This hardly makes them a secret. Information about tax credits is publicly available, and any reputable tax planner could point you to reliable tax savings opportunities.
Another red flag is the promise of guaranteed results, which is illegal. Reliable tax planners will always offer estimates based on their expertise and past experience rather than make promises they have no way of ensuring will come through.
Similarly, if the “promoters” of these supposed tax savings hacks refuse to provide more details on how the savings works or answer questions, that is a cause for concern. Shady companies may pretend their tax strategies are “confidential” or even require a non-disclosure agreement. This lack of transparency is a sign something is off. The reality is that no one owns the tax code. If a tax strategy is “secret,” how can anyone vet it to ensure it actually complies with tax law?
Finally, a legitimate tax strategy should have a proven history of successfully passing the scrutiny of the IRS. Now you will have to be careful even here because clever schemes may reference real laws or court cases related to the topic that make it sound plausible. However, closer inspection may reveal that these laws and court cases do not actually say that you can apply this tax credit in the ways promoters claim.
Digging Deeper with 5 Key Questions
If a potential red flag has caught your attention, how can you dig deeper to determine if a tax savings opportunity is real? Here are just a few questions tax professionals ask when making the same evaluations:
• What is the legal basis for this strategy?
• Who is offering the strategy?
• Has this strategy been tested?
• Does the strategy align with Congress’ priorities?
• What are the risks?
Remember, the evidence for any legitimate tax strategy should not be vague. You should be able to find a specific section of the Internal Revenue Code or IRS guidance, like regulations or rulings, that speak to this tax benefit.
You should also consider who is offering the strategy: is the promoter a trusted and qualified tax professional? Are they part of a reputable firm, or did their organization just form last year? If it’s the latter, that could be a sign that the company sprung up just to promote this tax scheme. In some cases, promoters may refuse to put their name in any of the documentation for the tax claim. This is definitely a red flag if the person advertising a supposed “amazing opportunity” is not willing to fully stand behind it.
Next, has the strategy been tested? Are there real-world examples of taxpayers who have successfully made a claim without IRS challenges or deficiency adjustments? Another way to verify the legitimacy of a strategy is to get the opinion of a reputable law firm that is well-insured. Don’t take a promoter’s word for it if they say an attorney has backed up their claim—do your research and make sure that attorney’s word is worth something.
A possible red flag is if a tax strategy cannot be linked to Congress’ priorities (at the time the tax credit came into effect). For instance, the tax credits previously introduced by the Inflation Reduction Act aligned with Congress and the Biden’s administration goal of incentivizing clean energy. Others may support community development or other federal goals.
Lastly, make sure you understand the risks. What happens if the IRS audits your return and determines your claim is illegitimate? Will you face a financial penalty? Jail time? Don’t make the mistake of assuming you can simply pay the tax owed and move on. More often than not, tax schemes result in a hefty fee after you combine the tax, penalties, and interest. Promoters of tax schemes are likely to downplay the risks or offer vague assurance on the topic—keep an eye out for this.
Summary
With enough due diligence and understanding of common red flags, you can avoid falling prey to a tax evasion scheme. Tax scams will try to create a sense of urgency, but this is self-serving—these promoters are looking to secure their own commission at your expense. By contrast, a reliable tax planner will take a proactive approach to tax strategy. Rather than rushing you to a decision, they will work with you to create a blueprint for how to maximize your tax benefits in a legal and effective way.
To learn more about trustworthy tax avoidance strategies, reach out to a Certified Tax Planner today.
