Loading the player...

What is 'Tax Avoidance'

Tax avoidance is the use of legal methods to modify an individual's financial situation to lower the amount of income tax owed. This is generally accomplished by claiming the permissible deductions and credits. This practice differs from tax evasion, which uses illegal methods, such as underreporting income to avoid paying taxes.

BREAKING DOWN 'Tax Avoidance'

Most taxpayers use some form of tax avoidance. For example, individuals who contribute to employer-sponsored retirement plans with pre-tax funds are engaging in tax avoidance because the amount of taxes paid on the funds when they are withdrawn in retirement is usually less than the amount the individual would owe. Furthermore, retirement plans allow taxpayers to defer paying taxes until a much later date, which allows their savings to grow at a faster rate.

Tax Avoidance Is Encouraged

Tax avoidance is built into the Internal Revenue Code (IRC), which spans more than 75,000 pages. Lawmakers have used the IRC to manipulate taxpayer behavior by offering tax credits, deductions and exemptions in various aspects of people’s lives including health care, saving and investing, education, energy use and other activities. The tax benefits available in qualified retirement plans are to promote self-sufficiency in retirement. The death benefit of a life insurance policy is exempted from taxes to encourage family protection. Capital gains are taxed at a lower rate to encourage more investments. Interest deductions on home mortgages foster more home ownership.

Tax Avoidance Complicates the Tax Code

The expanding use of tax avoidance in the tax code has led to it becoming one of the most complex tax codes in the world. Taxpayers spend billions of hours each year filing tax returns with much of that time used looking for ways to avoid paying higher taxes. Because the tax code is always changing, families have a difficult time making decisions about retirement, savings and education. Businesses especially suffer the consequences of an ever-evolving tax code that affects their hiring decisions and growth strategies. Since 2006, nearly 4,500 federal tax rule changes have been made to the tax code, most having to do with tax avoidance provisions.

Tax avoidance is at the core of most proposals seeking to reform the tax code. The proposals that have been introduced over the last decade seek to simplify the tax code by flattening the tax rates and removing most tax avoidance provisions. Tax reform proposals assume a lower, flat tax rate would eliminate the need to pursue tax avoidance strategies.

RELATED TERMS
  1. Effective Tax Rate

    The average rate at which an individual or corporation is taxed. ...
  2. Tax Break

    A tax break is a savings on a taxpayer's liability. A tax break ...
  3. Tax Liability

    The total amount of tax that an entity is legally obligated to ...
  4. Tax Deductible Interest

    A borrowing expense that a taxpayer can claim on a federal or ...
  5. IRS Publication 514

    A document published by the Internal Revenue Service that provides ...
  6. Tax Reform Act Of 1986

    A law passed by the United States Congress to simplify the income ...
Related Articles
  1. Taxes

    Why The Complex U.S. Tax Code Won't Be Simplified

    The tax code is 5296 pages long, and it still hasn't been abridged by Congress. Find out why.
  2. Taxes

    Who Does The Current Tax Code Benefit?

    Are the non-workers benefiting from the current tax code in any way or is it the wealthy who are still getting the big breaks?
  3. Insights

    How Fortune 500 Companies Avoid Paying Income Tax

    President Donald Trump is not alone in not paying taxes.
  4. Taxes

    The Most Controversial Tax Deductions

    When it comes to taxes, it's hard to make people happy but these deductions raised more than the average amount of controversy.
  5. Taxes

    What's IRS Form 1040 For?

    Most U.S. taxpayers will be familiar with the 1040. By the end of filling it out, you'll know how much tax you owe, or what your refund is.
  6. Insights

    A Concise History Of Changes In U.S. Tax Law

    We look at how U.S. taxes have changed since their inception.
  7. Taxes

    Making Sense Of The Tax Code

    If tax rules and regulations are Greek to you, read on to learn how to decipher them.
  8. Taxes

    How The Wealthy Slash Their Income Tax Bills

    Many of these tax-minimization strategies can be used by anyone. Find out how you can pay taxes like a millionaire.
  9. Taxes

    5 State Tax Issues For When You Leave the Military

    When you're budgeting for post-military life, certain state tax issues need to be considered.
  10. Taxes

    The History Of Taxes In The U.S.

    The number of taxes that we now consider a given did not always exist. Find out how they arose.
RELATED FAQS
  1. What is the justification for allowing deferred tax liabilities?

    Understand the justification for allowing deferred tax liabilities. Learn the reasoning behind why a company would want to ... Read Answer >>
  2. How does the marginal tax rate system work?

    The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. As the marginal tax ... Read Answer >>
Hot Definitions
  1. Fixed-Income Security

    An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. ...
  2. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  3. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  4. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  5. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  6. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
Trading Center