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plans with pre-tax funds are engaging in tax avoidance because the amount of taxes paid on the funds when they are withdrawn in retirement is usually less than the amount the individual would owe.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

    A tax that is paid directly by an individual or organization ...
  5. Tax Base

    The assessed value of a set of assets, investments or income ...
  6. Flat Tax

    A system that applies the same tax rate to every taxpayer regardless ...
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

    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.
  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

    Calculating Net of Tax

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

    Use Tax Vs. Internet Sales Tax: How Are They Different?

    Learn about the differences between a use tax and an Internet sales tax. Find out about transactions in which the taxes apply, and to whom they apply.
  8. Taxes

    Understanding Taxes

    Taxes are mandatory fees that individuals and corporations must pay to their governments.
  9. Taxes

    Making Sense Of The Tax Code

    If tax rules and regulations are Greek to you, read on to learn how to decipher them.
  10. 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.
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. How can I lower my effective tax rate without lowering my income?

    Discover how to reduce your effective tax rate without losing income by maximizing adjustments and deductions, earning tax-free ... Read Answer >>
  5. What is the difference between a write-off and a deduction?

    Understand the differences between a tax write-off and a tax deduction. Learn how each one works to reduce income taxes and ... Read Answer >>
Hot Definitions
  1. Co-pay

    A type of insurance policy where the insured pays a specified amount of out-of-pocket expenses for health-care services such ...
  2. Protectionism

    Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local ...
  3. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  4. Demonetization

    Demonetization is the act of stripping a currency unit of its status as legal tender and is necessary whenever there is a ...
  5. Investment

    An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic ...
  6. Redlining

    The unethical practice whereby financial institutions make it extremely difficult or impossible for residents of poor inner-city ...
Trading Center