Tax Evasion and Tax Avoidance, from Life in the USA: The Complete Guide for Immigrants and Americans

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Life in the USA
Personal Finance

Tax Evasion and Tax Avoidance
Your tax can be legally reduced for many reasons. The more dependents you have, the lower your tax rate. If you have certain medical expenses or if you contribute to certain retirement plans, the portion of your income that is taxed may be reduced. There are many other legal methods of lowering your tax bill.

Tax Evasion. There are also illegal methods. “Evading” taxes is illegal, though the phrase “avoiding taxes” refers to tax reduction strategies that are within the law. A person who works for someone else will probably receive income “on the books,” meaning that taxes are withheld and the IRS computer notified of all income. A self-employed person is also supposed to “declare” all his or her income, even cash, to the tax authorities. The tax people have sophisticated ways of tracking down income, and penalties for tax fraud are severe: not only prison terms but money penalties that can double and triple your tax bill. Contrary to popular belief, however, the IRS does not automatically know you have earned money just because you have been paid by check. It will find this out only if you are investigated (“audited”), or if the person paying you reports the payment to the IRS through a “1099” or W2 form.

The Internal Revenue Service (IRS) audits a small number of taxpayers at random, but most audits are a result of “red flags.” If a person claims too many deductions in proportion to his or her income, or if a person with a great many assets claims a very small income, an audit may result. Many people trying to evade taxes get into trouble when they become too greedy.

Life Off the Books. A vast “underground economy” exists in the United States, covering a wide range of goods and services, both legal and illegal. Many people do business or work on a strictly cash basis and are entirely outside the tax system. Other people do pay taxes on some of their income but keep much of their income “off the books.”

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