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plans with pre-tax funds are engaging in tax avoidance because the amount of taxes paid on the funds when they are withdrawn in retirement is usually less than the amount the individual would owe.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. Tax Liability

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

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

    A document published by the Internal Revenue Service that provides ...
  4. Tax Credit

    An amount of money that a taxpayer is able to subtract from the ...
  5. Tax Exempt

    To be free from, or not subject to, taxation by regulators or ...
  6. Tax Benefit

    A tax benefit is an allowable deduction on a tax return intended ...
Related Articles
  1. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  2. Insights

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

    We look at how U.S. taxes have changed since their inception.
  3. Financial Advisor

    3 Federal Income Tax Facts You Didn't Know

    Learn about three federal income tax facts that most Americans may not know from one of the most trusted financial resources on the Web.
  4. 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.
  5. Taxes

    How Much Tax Do You Really Pay?

    When you add direct and indirect taxes together, your real tax rate is much more than you expected.
  6. Taxes

    Calculating Net of Tax

    Net of tax is a figure that has been adjusted for taxes.
  7. Taxes

    Could The Fair Tax Movement Ever Replace The IRS?

    Although many taxpayers would love to see the IRS abolished, only a handful of thinkers have come up with any sort of viable replacement plan. The Fair Tax is one such idea that has continued ...
  8. Taxes

    Why America's Taxes Are Too Low

    The solution to America's economic woes may not be in lowering taxes further, but may, in fact, lie in increasing them.
  9. Taxes

    Tax Haven Vs. Tax Shelters: Is There a Difference?

    Learn about the difference between tax havens and tax shelters, and how both are used to reduce tax liability or avoid paying taxes altogether.
  10. Taxes

    Preparing for Potential Tax Policy Changes

    Here is a comprehensive guide to tax planning in an environment where policies could dramatically change under new leadership in Washington.
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. What is the difference between a state income tax and a federal income tax?

    Learn the difference between state income tax and federal income tax based on tax rates, deductions, tax credits and taxable ... Read Answer >>
  3. 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 >>
  4. Who first came up with the idea of a progressive tax?

    Learn how the progressive income tax system developed in the United States and became the federal government's primary revenue ... Read Answer >>
  5. How does the effective tax rate for an individual differ from that of a corporation?

    Read about the effective tax rate for individuals when compared with the effective tax rate for corporations, including how ... Read Answer >>
Hot Definitions
  1. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  6. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
Trading Center