Question

1.Think about the primary difference between tax avoidance and tax evasion. Define and provide an example of each, and compare/contrast the typical consequences a taxpayer can expect from the Internal Revenue Service when s/he engages in either of the behaviors. In your response, identify the legal doctrines that the IRS typically uses to challenge a tax planning strategy.

2.Explain what is meant by an “implicit tax.” Define an implicit tax, and illustrate the concept by showing how a taxpayer’s marginal tax rate will determine whether s/he should invest $10,000 in a fully taxable corporate bond generating pretax interest of 8%, or a municipal bond generating pretax interest of 6%. At what marginal tax rate will an investor be indifferent between the two options?

Answer 1

Answer:-

1. No one likes to pay tax , but taxes are the Law. Thes two terms " Tax Avoidance " and "Tax Evasion are ofently used interchangeably , but they are very different Concepts. Tax Avoidance is legal whereas Tax Evasion is not.

Primary Difference of Tax Avoidance and Tax Evasion is shown in table below:

TAX AVOIDANCE	TAX EVASION
Minizing of tax	Not Paying Tax
Example: Using legitimate tax deductions, setting up tax deferral plans, taking tax credits	Example: Not reporting income,reporting more expenses than you can, not paying taxes owed,understanding your tax amount owed.

Concepts of Tax Avoidance and Tax Evasion are briefly explained with an example as follows:

(1) Tax Avoidance:- It is Legitimate minimizing of taxes and maximize after tax income this method using included in the tax code.By taking all legitimate deductions and tax credits Business avoides tax credits . By sheltering income from taxes by setting up employee retirement plans and other means . All legal and under the Internal Revenue Code or State Tax code.

Examples :

(i) taking Legitimate tax deductions to minimize business expenses and lower your business tax bill.

(ii) taking tax credits for spending money for legitimate purposes,like taking a tax credit for giving your employees paid family leaves.

(iii) Setting up tax deferral plan such as an IRA ,SEP -IRA , or 401k plan to delay taxes until a later date.

Tax Loopholes is tax avoidance.Its a way to avoid paying taxes ,but since it's in the tax code t's not evasion.If you are tempted to use a tax loopholes ,be aware that the tax laws are complex and difficultt to interpret.Tax sheilds is another stratergy for avoiding taxes.A tax sheild is a deliberate use of tax tax expenses to offset taxable income.

(2) Tax Evasion:- On the other hand Tax evasion ,is using illegal means to avoid paying taxes .Usually tax evasion involes hiding or misrepresenting income.This might be underreporting income,,inflation deductions without proof , hiding or not reporting cash transactions or hiding money in offshore accounts.

The internal revenue code says that the willful attempt to "evade or defeat any tax" law is guilty of a felony.If convicted,tax evasion can result in fines upto $2,50,000 for individuals and $5,00,000 for corporations , or fine upto five years or both.

Examples:

(i) Not reporting an income source

(ii) Providing false information to the IRS about Business income or expenses .

(iii) Under reporting income (claiming) less income than you actually received from a specific source, particularly cash income.

(iv) Overstating the amount of deductions

(v) Keeping two sets of books

(vi) Hiding or transferring assets or income.

Subject to fines and and penalties legal doctrnies from the IRS for tax stratergies they consider -

(a) Knowing the tax laws :

For income taxes and and employment taxes should be known.For example, knowing what deductions are legal and the recordkeeping requirements for deductions is a big factor in avoiding an Audit.

(b) Tax professionals to help:

Getting an honest and careful tax professional to hepl you with your taxes Keeping record of all income and expenses by listening to your tax preparer.

2. IMPLICIT TAX :

An Implicit tax is simply the effect of taxes on the price of an asset.For example- if an asset is tax preferred ,the price will be bid up to reflect the tax preference.To avoid missteps one must think explecitily about implicit taxes.

For two investments of equal risk and maturity the after tax return must be same .If not the investment with lower return would be shunned and everyone would buy the investments with higher return causing the pretax return(i.e. ,the yields) of the investments to adjust until the after tax returns are same.

If the invester wants to invest $10,000 in fully taxable corporate bonds generating pretax interest of 8% then,

10,000*8%= $800

If the invester wants to invest $10,000 in fully taxable muncipal bonds generating pretax interest of 6%, then

10,000*6% = $600

So, the investor would be indifferent between two options is invest the investments with higher return i.e. corporate bonds.