The Difference Between Tax Avoidance and Evasion (Examples)

What is Tax Avoidance vs Tax Evasion (Common Examples)

What is Tax Avoidance vs Tax Evasion?

When it comes to U.S. taxpayers seeking to minimize their U.S. tax liabilities, two common phrases that often get tossed around together are ‘tax evasion’ and ‘tax avoidance.’ While tax evasion is a serious tax crime, tax avoidance (when done properly) is not illegal. The key difference between tax avoidance and tax evasion is that tax avoidance utilizes legal strategies to try and reduce taxes, whereas tax evasion is an unlawful tax crime. In other words, simply trying to avoid or minimize taxes is not illegal, whereas tax evasion is illegal. Let’s look at a few common examples to explain the difference between tax avoidance and tax evasion.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA) unless stated in the example. Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Tax Avoidance

Tax avoidance is when a taxpayer attempts to legally reduce or minimize their U.S. tax liability by implementing certain tax strategies. It is important to note that when executed properly, tax avoidance is legal — which means that the taxpayer does not seek to violate the law to minimize their tax artificially, but instead to reduce their U.S. tax liability by using legal strategies:

• • • Example: Brian is a lawful permanent resident who will soon relocate overseas to work. The foreign country where Brian will be working is a treaty country and Brian will be working in that country 12 months out of the year and develop significant and substantial contacts in that country. The tax rate in the foreign country is much lower than in the United States and Brian considers making a Form 8833 treaty election to be treated as a non-resident alien for tax purposes. This means that if Brian qualifies for the election, he will only be taxed by the U.S. government on his US-sourced income and not his worldwide income.

    • Example: Brenda is a U.S. person who was offered employment overseas and the opportunity to choose from a few different countries for which location she wants to work form. One of the countries does not have personal income tax and Brenda will also qualify for the foreign earned income exclusion under U.S. tax law. If Brenda relocates to the country that has no foreign tax on her employment income, she will also have avoided a significant amount of U.S. tax on her income as well.

    • Example: Billy is a U.S. visa holder who has been working in the United States for the past few years. Recently, Billy was offered the opportunity to transfer to a different country for work. In addition, Billy stands to inherit a significant amount of income generating foreign assets from non-resident alien family members. If Billy is not a U.S. person for tax purposes when he receives the inheritance, he will not be taxed on his worldwide income. Since Billy does not intend on growing his family in the United States, Billy decides he will move to the foreign country to work instead of the United States. As a result, he does not meet the substantial presence test (so he is not taxed on his worldwide income).

Tax Evasion

Unlike tax avoidance, which is a legitimate strategy for reducing overall U.S. tax liability, tax evasion is the process of committing a tax crime, which is illegal and may result in significant fines and penalties along with incarceration:

• • • Example: Charlie is a U.S. citizen who wants to earn income overseas but not report that income in the United States. He finds a company/promoter overseas that helps U.S. taxpayers avoid U.S. taxes by forming a legal entities and then holding foreign bank accounts and assets under those entities so that the U.S. government does not learn about the income. When Charlie files his U.S. tax return, he knowingly does not include this foreign income. Unfortunately for Charlie, the foreign institution decided to cooperate with the U.S. government and ultimately provide the government with U.S. taxpayer information — including Charlie. Charlie may become subject to a criminal tax investigation.

    • Example: Christopher is a lawful permanent resident who recently realized that he should have reported a 7-figure gift that he received from his non-resident alien grandma a few years ago. Christopher does not want to risk significant fines and penalties, so he uses his foreign identification to open a bank account in a foreign country and intentionally misrepresents on the application that he is not a U.S. citizen nor lawful permanent resident. Christopher did this for the sole purpose of hiding his U.S. person status from the foreign institution in hopes they would not report his account to the IRS. When Christopher files his U.S. tax return he intentionally excluded the income generated from the account, the FBAR, Form 8938, and Form 3520. Unfortunately, the country where the foreign financial institution entered into a FATCA agreement with the United States and provided Christopher’s name to the U.S. government. Christopher may become subject to a criminal tax investigation.

    • Example: Caleb is a U.S. citizen who purchased several rental properties in a foreign country. He transferred all of the properties to a non-resident alien in order to avoid having to pay U.S. taxes on the income by showing he did not own the property. However, even though the properties are in a third party’s name, it was a fraudulent transfer since Caleb still receives the money from the transferee. In addition, Caleb intentionally excludes the income from his U.S. tax return. Caleb may become subject to a criminal tax investigation.

Late-Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.