Tax Avoidance and Evasion Paper Example

Part A: Tax liability is the amount payable to the government of a sovereign state less allowable deductions.

There are two types of tax assessments used. The first is self-assessment where taxpayers are tasked with the duty to declare all relevant information on their incomes and expenditures and consequently asses then report their tax liability. The second is, direct assessment where the statutory tax authorities are tasked with the duty to collect tax information from tax payers and assess the resultant tax liability (Palil, 2010).

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The most important factor to consider is whether the selected tax assessment system prompts compliance among tax payers. Tax laws compliance provide the basis discussion on tax evasion and tax avoidance. For any government in the world, assessment and compliance with taxation do not only create a sense of economic equality among the citizens, but also, it allows them to deliver their mandate to the public including utilities and services efficiently without unnecessary financial constraints. The integrity of this process however faces challenges of tax avoidance and tax evasion, both actions are crimes under the federal laws of the United States of America and the offenders are liable to imprisonment and heavy fines. The following essay seeks to expound on the differences between tax evasion and tax avoidance and give examples of each by referring to select court cases and also discuss whether tax liability minimization is a form of tax evasion or tax avoidance.

Tax avoidance is the reduction of taxes payable using legal means allowed in a particular country as laid out by the respective tax commission. According to "Forbes Welcome"(2018), this of profit shifting costs the world's economies approximately $600 billion, with the US leading the loss list at a figure of $189 billion annually. Studies, such as that done by Mehrara and Farahani (2016), shows that one of the highest cause of tax avoidance is the escalated rate of taxation. High taxation rates essentially create an enticement for the tax payers to misrepresent their profits in order to lower their tax liabilities. On the extreme practice, tax avoidance confronts the government with budget deficiencies because of revenue to expenditure disproportionate ratios and this causes an adverse impact on the country's economic stability.

In the United States of America, the court has discretion on interpretation on whether tax avoidance measures are compliant with the law. Tax avoidance cases are dynamic in nature and the courts themselves do not have a particular consistent set of rules to when giving a verdict but the ruling principally depends on the substance of the transaction under dispute. The intention for tax planning by an individual should be investigated to ensure that they have economic substance as opposed to being used for tax reduction only. There have been many court cases regarding tax avoidance and one the monumental cases that helped in definition of tax avoidance is of Gregory v. Helvering (1935). In the case the petitioner had claimed reorganization of a company such that there was a transfer of shares through an organized corporation, Averil. This would have enabled the petitioner to have a lower tax payable than that levied on received the dividends. The reorganization would have been legal had the purported corporation been created for the sole purpose of continuing business.

Tax avoidance can be carried out in various ways such as claims for deductions in losses incurred. As stated in the case Higgins v. Smith (1940) under subsection 23 (e) deductions are permitted for losses sustained during the taxable year. The case had been intended to determine whether a taxpayer was entitled to reduce tax liability by deducting loss arising from a securities sale to his/her fully owned corporation. A loss is considered sustained when realized by a completed transaction determining its amount. Losses allowable for deductions include: those incurred by individuals in a particular taxable year and are not compensated for, those that arise in the trade or business operations and those that are incurred in transactions meant for profit despite being separate from the business (Bittker, & Kanner 1978). One can also claim tax credits for taxes paid in foreign countries either by subsidiary or parent company, provided such credits arise from transactions with economic substance. Taxation should be based on income earned. Therefore, it makes sense to allow tax payers reduce tax liability by deducting losses that cut into net earnings. This form of tax avoidance should be undertaken subject to set legal limitations.

Another interesting aspect of tax avoidance is that, it can be sustained by the court of laws. A taxpayer can seek to reduce or avoid tax based on a bona fide debt. In Zimmerman v. United States (1963), a landmark case that introduced new parameters for tax avoidance grant, the petitioner claimed tax deduction on a debt that had proven irrecoverable. However, it was established that the requisite factors for such a claim were not in existence. As such he could not use irrecoverable amounts to avoid tax by deducting it from his tax liability. A bona fide debt is due that results from the establishment of a debtor-creditor relationship, one whose basis is a valid and legally enforceable obligation to pay a predetermined amount of money and one with a definite payment period; Debts only qualify as allowable tax deductions if they satisfy the mentioned conditions (Schwerdtfeger, 1953). A tax-payer can therefore avoid tax by use of debts that are considered irrecoverable after evaluation of underlying factors so long as he acts within the limits of the law.

Tax evasion, on the other hand, is a criminal offence. It refers to willful actions by a taxpayer intended to reduce his/her tax liability through illegal means. According to Mathews (2018), the federal government lost an average of $458 billion per year in the period between 2008 and 2010. These statistics compared to the annual $189 billion accrued to tax avoidance shows the notoriety of business in tax evasion practices. It is punishable either by fine or prison sentence or both.

In the aforementioned case: Gregory v. Helvering (1935) the petitioner had intended to create a corporate reorganization of Mortgage Corporation in which she was the sole shareholder. The new corporate structure would enable a share transfer to an organized corporation and later a transfer to herself thus minimizing expected tax payable. By reorganizing the mortgage firm, transfer of assets in full or in part to a separate corporation in which the transferor or its stockholders have immediate control would be possible, which would allow all the jurisdictions under this form of business including the terms of taxation (Thuronyi, 1998). However the law allows this practice only if there is proof of economic substance which the petitioner ,within the legal framework ,implemented. The issue with this particular case, however, was the underlying intention. The reorganization had been intended only for the reduction of tax liability, which is in fact a primary proof of tax evasion.

Tax evasion can take many forms such as failure to report all incomes, use of false invoices, hiding incomes in offshore accounts, claims on unearned deductions or credits, failure to provide requisite information as and when demanded by relevant authorities. However, the Internal Revenue Service categorizes tax evasion into two types, evasion of assessment and evasion of payment. under evasion of assessment, IRS outlines that elements such as attempt to evade tax, additional tax due or proof of willful evasion as the basis of tax prosecution. Majority of the offenders of this clause are found guilty for transferring assets to the family member accounts or even foreign accounts to prevent the IRS from getting the actual tax liability of their business. Additionally, a taxpayer may file returns that omits an income or one that includes a false deduction to ensure make the tax liability even lower than the true value. All these attributes lead to a breach of tax compliance provisions of the internal Revenue Code 26 USC subsection 7201 (IRS,2018).

Regarding evasion of payment, as opposed to evasion of assessment where the taxpayer willfully conceals assets prior IRS assessment, evading payment involves concealing of assets the assessment by the IRS.one of the widely used method as to check evasion of payment is tax liability comparison. Under this method, the taxpayers and the tax commission make separate computations for an individual's tax liability the final outcome for both computations should all the same tally. where significant disparity between the two arises, there may be basis for tax evasion charges. This concept is shown in the case: Smith v. United States (1954) where the government discovered that the increase in the petitioner's net worth was in excess of the reported incomes for the prosecution years 1945-1949. Such increments consisted of taxable incomes thus the petitioner was guilty of tax evasion as he had continually filed returns below his earned income over the prosecution period. A taxpayer has a responsibility to disclose all sources of income at correct amounts, failure to do so places him/her at risk from tax evasion charges.

Where a taxpayer receives income from an offshore account, such income is taxable in his domicile and should be reported. When US firms or citizens invest in foreign countries with lower tax rates, a higher federal income tax is charged on foreign income earned ((Dyreng & Lindsey, 2009). Based on this, taxpayers may attempt to avoid the high federal tax by failing to report foreign income earned thus prompting charges to be brought against them. A very good example case of this form of tax evasion is that of United States v. Warner (2015). In this case, the defendant is said to have invested in an offshore account based in Switzerland at UBS. In a bid to avoid reporting such earnings to the IRS, Warner gave instructions that all account documents be destroyed, that no correspondence should be sent to him and stated in his annual report that he had no financial foreign account. For tax reduction to be legal there has to be voluntary full disclosure otherwise the actions are proof of tax evasion.

According to Amadeo (2015), the American annual budgetary deficit is estimated at $474 billion, a figure that is very close to the total amount loses to rampant tax evasion. While according to the amount lost to evasion amounts to only 8.9% of the gross domestic product, this amount could solve the glaring deficit in the economy. to close the tax gap, one of the best method to curb evasion has been increasing the penalty for tax non-compliance. By using this risk-reward concept for evaders, corporations and individual will opt to comply with tax requirements rather than evading and incurring even higher charges.

The basic distinction between tax avoidance and tax evasion is legality. Provided tax reduction measures are undertaken in such a way that there is full disclosure, proof of economic substance and compliance with relevant tax laws then tax avoidance is successful. However, the court holds discretion on whether such tax liability reduction is allowable. Tax evasion arises where tax minimization is carried out with deceit such that there is clear manipulation of the law. Despite this distinction there is still a very thin line between tax evasion and tax avoidance.

Part B: Discussion on Whether Tax Minimization Fall Under Tax Evasion or Tax Avoidance.

Progressive tax system requires that tax liability should be based on the taxpayer's ability to make contribution.as such, the statutory provi...