Richard recently received $10,000 of compensation for some consulting work (paid in cash). Jeffrey recently received $10,000 of interest income from city of Dallas bonds. Both taxpayers report no taxable income from these transactions. Is this considered tax avoidance or tax evasion? What is the difference, if any, between the two?

Question

What will be an ideal response?

Answer 1

Richard is engaged in tax evasion. Jeffrey is engaged in tax avoidance. Tax avoidance is the legal act of arranging one's affairs to minimize taxation. The rewards of tax avoidance include maximizing the taxpayer's wealth. It has long been endorsed by the courts and Congress. In contrast to tax avoidance, tax evasion (willful intent to defraud the government) falls outside the confines of legal tax avoidance. The"rewards" of tax evasion include civil and criminal penalties, including large monetary fines and sentencing to federal prison. In many cases there is a clear distinction between avoidance (e.g., not paying tax on municipal bond interest) and evasion (e.g., not paying tax on $10,000 of compensation). In other cases, the line between tax avoidance and evasion is less clear. In these situations, professional judgment, the use of a "smell test," and consideration of the business purpose, step-transaction, and substance-over-form doctrines may prove useful.