Legal Definitions - tax avoidance

Tax avoidance refers to the legal practice of structuring one's financial affairs to minimize the amount of tax owed. It involves utilizing provisions within tax laws, such as deductions, credits, exemptions, and deferrals, that are explicitly permitted by the government. The goal is to reduce tax liability through legitimate means, distinguishing it from illegal tax evasion.

Here are some examples illustrating tax avoidance:

• A person contributes the maximum allowable amount to their 401(k) retirement account each year.

  This illustrates tax avoidance because contributions to a 401(k) are often tax-deductible, meaning they reduce the individual's taxable income for that year. This is a legally sanctioned method of deferring or reducing tax liability, as the government encourages retirement savings through such incentives.

• A homeowner deducts the interest paid on their mortgage and property taxes from their taxable income.

  This demonstrates tax avoidance because tax laws in many jurisdictions allow homeowners to deduct these specific expenses. By claiming these legitimate deductions, the homeowner legally reduces their overall taxable income, thereby lowering their tax bill.

• A small business invests in new, energy-efficient machinery for its operations, qualifying for a government-provided tax credit.

  This is an example of tax avoidance because governments often offer tax credits to businesses that make specific types of investments, such as those promoting environmental sustainability. By purchasing the qualifying machinery, the business legally reduces its tax liability by the amount of the credit, as intended by the tax code.