Tax avoidance refers to the legal practice of arranging your personal or business financial affairs to minimize tax liability within the bounds of the law. Unlike tax evasion, which is a deliberate and illegal failure to pay one’s taxes, tax avoidance is perfectly legal. In fact, it’s just smart business, especially if you own your own company.
Tax avoidance involves using legitimate saving strategies and taking advantage of available tax incentives and deductions to reduce the amount of taxes you owe. It’s often done with the assistance of financial professionals and can involve long-range financial planning.
What sort of tax avoidance strategies are there?
Here are a few examples of tax avoidance strategies that are generally legal to use:
- Tax-efficient investments: Investing in tax-advantaged accounts such as Individual Retirement Accounts (IRAs) or 401(k) plans allows high-income individuals to defer taxes on the income generated on those funds until their withdrawal.
- Capital gains and losses: By strategically timing the sale of assets, individuals and businesses can take advantage of the lower tax rates applied to long-term capital gains. Additionally, capital losses can be used to offset capital gains, reducing overall tax liability.
- Tax deductions and credits: Using legitimate deductions and credits available under tax laws can reduce taxable income for both businesses and individuals. Examples include deductions for mortgage interest, charitable contributions, education expenses and business expenses.
- Tax treaties: International tax treaties provide mechanisms to avoid double taxation for individuals and businesses operating in multiple countries. These agreements help allocate taxing rights and prevent income from being taxed twice.
- Incorporation: Businesses may organize themselves in ways that legally minimize their tax liability. For instance, choosing to incorporate in a jurisdiction with favorable tax laws or structuring a business as a pass-through entity like a partnership or S corporation can offer certain tax advantages.
It is important to note that while tax avoidance is legal, the government often aims to close tax “loopholes” through legislative measures. That can make it particularly challenging to understand what strategies are currently legal to use – and what might affect your long-range planning.