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Tax Avoidance

Definition

Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. Tax sheltering is very similar, although unlike tax avoidance tax sheltering is not necessarily legal. Tax havens are jurisdictions which facilitate reduced taxes.

What is 'Tax Avoidance'

Tax avoidance is the use of legal methods to modify an individual's financial situation to lower the amount of income tax owed. This is generally accomplished by claiming the permissible deductions and credits. This practice differs from tax evasion, which uses illegal methods, such as underreporting income to avoid paying taxes. Next Up Effective Tax Rate Tax Break Tax Deductible Interest IRS Publication 514

Explaining 'Tax Avoidance'

Most taxpayers use some form of tax avoidance. For example, individuals who contribute to employer-sponsored retirement plans with pre-tax funds are engaging in tax avoidance because the amount of taxes paid on the funds when they are withdrawn in retirement is usually less than the amount the individual would owe. Furthermore, retirement plans allow taxpayers to defer paying taxes until a much later date, which allows their savings to grow at a faster rate.

Tax Avoidance Is Encouraged

Tax avoidance is built into the Internal Revenue Code (IRC), which spans more than 75,000 pages. Lawmakers have used the IRC to manipulate taxpayer behavior by offering tax credits, deductions and exemptions in various aspects of people’s lives including health care, saving and investing, education, energy use and other activities. The tax benefits available in qualified retirement plans are to promote self-sufficiency in retirement. The death benefit of a life insurance policy is exempted from taxes to encourage family protection. Capital gains are taxed at a lower rate to encourage more investments. Interest deductions on home mortgages foster more home ownership.

Tax Avoidance Complicates the Tax Code

The expanding use of tax avoidance in the tax code has led to it becoming one of the most complex tax codes in the world. Taxpayers spend billions of hours each year filing tax returns with much of that time used looking for ways to avoid paying higher taxes. Because the tax code is always changing, families have a difficult time making decisions about retirement, savings and education. Businesses especially suffer the consequences of an ever-evolving tax code that affects their hiring decisions and growth strategies. Since 2006, nearly 4,500 federal tax rule changes have been made to the tax code, most having to do with tax avoidance provisions.


Further Reading


The economic effects of financial derivatives on corporate tax avoidance
www.sciencedirect.com [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Corporate tax avoidance and firm valueCorporate tax avoidance and firm value
www.mitpressjournals.org [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Corporate governance, incentives, and tax avoidanceCorporate governance, incentives, and tax avoidance
www.sciencedirect.com [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Tax avoidance and the deadweight loss of the income taxTax avoidance and the deadweight loss of the income tax
www.mitpressjournals.org [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Corporate tax avoidance and high-powered incentivesCorporate tax avoidance and high-powered incentives
www.sciencedirect.com [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Long‐run corporate tax avoidanceLong‐run corporate tax avoidance
meridian.allenpress.com [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

The social irresponsibility of corporate tax avoidance: Taking CSR to the bottom lineThe social irresponsibility of corporate tax avoidance: Taking CSR to the bottom line
link.springer.com [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Effect of tax avoidance and tax evasion on personal income tax administration in NigeriaEffect of tax avoidance and tax evasion on personal income tax administration in Nigeria
www.worldscholars.org [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …

Corporate ownership, governance and tax avoidance: An interactive effectsCorporate ownership, governance and tax avoidance: An interactive effects
repo.uum.edu.my [PDF]
This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to …



Q&A About Tax Avoidance


What does it mean that tax avoidance is built into the Internal Revenue Code (IRC)?

The IRC contains many provisions designed to encourage taxpayers to make certain decisions in their lives, including saving for retirement or buying a home. These provisions are called "tax incentives" or "tax breaks."

What is tax avoidance?

Tax avoidance is the use of legal methods to modify an individual's financial situation to lower the amount of income tax owed. This is generally accomplished by claiming the permissible deductions and credits. This practice differs from tax evasion, which uses illegal methods, such as underreporting income to avoid paying taxes.

Why do some companies experience backlash from their active customers or online?

Because their customers believe that they should be paying more money than what they are currently paying.

Where do most businesses and corporations take part in this practice?

Most businesses and corporations take part in this practice online.

How can lawmakers manipulate taxpayer behavior using the IRC?

Lawmakers offer various incentives and breaks in order to encourage taxpayers' actions they deem beneficial. For example, if lawmakers believe that people should save more money for retirement, they may offer a deduction for retirement savings contributions in order to incentivize people to save more money for their later years. However, because these benefits are offered through the IRC rather than through direct spending programs funded by Congress with taxpayer dollars, lawmakers must pay for them either by reducing other government services or increasing taxes on others who do not receive those benefits. Therefore, when lawmakers enact new tax breaks like this one encouraging retirement savings contributions, they must offset them with higher taxes elsewhere or reduced funding for another government service such as national defense or education spending. In short, while these benefits may be intended as "breaks," they actually come at a cost—higher taxes on others who do not receive those particular benefits; therefore making them really just disguised forms of taxation rather than true "breaks."

Why would families have difficulty making decisions about saving and investing?

Families have difficulty making decisions about saving and investing because there are so many different rules regarding what types of investments qualify for specific deductions or credits and how much you can deduct each year

How can you tell if an activity is considered tax avoidance?

If it uses legal methods but still reduces taxes owed, then it is considered as being used for avoiding taxes.

What does it mean when people say they are using a tax shelter?

It means they are using a legal entity or structure to avoid paying taxes.

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