Tax Evasion and Tax

Tax Avoidance vs. Tax Evasion The main objective of a tax advisor is to assist his/her clients avoid taxes as much as possible through within the confines of the law in order to avoid crossing the line into tax evasion. In this case, the tax advisor guides his/her clients based on the law regarding tax avoidance and tax evasion. This paper focuses on comparing the concepts of tax avoidance and tax evasion based on Gregory v. Helvering case as well as other cases that mention this case.

In this case, the paper will include a discussion of tax avoidance and tax evasion based on cases citing Gregory v. Helvering case. The use of these cases in the discussion is for the purpose of enhancing understanding of tax avoidance and tax evasion and how an individual can avoid evading taxes. This paper will also discuss whether tax liability minimization falls under either tax avoidance or tax evasion.

Comparison of Tax Avoidance and Tax Evasion The American income tax system is based on the notion of voluntary compliance through which the taxpayer has the responsibility of report all his/her income. However, taxation remains to be a highly controversial and divisive issue among many people. As a result, some people attempt to avoid or evade taxes including through failure to report some of their money-making activities, which is considered illegal and a violation of the law.

The tendency by some individuals to evade taxes is also attributable to the principle of voluntary compliance, which is the basis of the income tax system. Through this principle, the government requires and expects all individual citizens to report their income voluntarily and freely. During the reporting, the individual citizen is expected to calculate his/her tax liability correctly and file his/her tax returns in a timely manner. However, this is not always the case given the increased adoption of tax avoidance and tax evasion strategies by taxpayers (Murray, 2017).

Throughout the years, tax avoidance and tax evasion are concepts that have constantly been used interchangeably though they are essentially different. The major difference between tax avoidance and tax evasion is that the former is legal while the latter is illegal (Murray, 2017). As a result, individuals or businesses get into trouble with the Internal Revenue Service (IRS) when they attempt to engage in deliberate tax evasion strategies or activities.

However, individuals or businesses can engage in strategies to avoid paying taxes through the help of a tax advisor without getting into trouble with IRS. Tax avoidance can be described as actions undertaken by a taxpayer (either an individual citizen or business) to reduce tax liability and maximize income after taxation. Based on regulations by the Internal Revenue Service, eligible taxpayers are permitted to claim income adjustments, credits, and deductions in order to lessen their total tax liability.

For instance, businesses can avoid taxes through establishing employee retirement plans or using other legal mechanisms to reduce their taxes. An example of a case that cite Gregory v. Helvering and demonstrates the legality of tax avoidance is The Sherwin Williams Company v. Commissioner of Revenue. In this case, the plaintiff, Sherwin Williams challenged the 1991 tax assessment and the rejection of nearly $47 million that the taxpayer deducted from its taxable income for royalty payments that the company had made two investment firms (Leagle, 2002).

The Supreme Court found that Sherwin-Williams was not motivated by tax avoidance when making payments to the two passive investment companies. Additionally, the transactions made by the plaintiff has practical economic impacts since they were not motivated by tax avoidance and tax benefit purposes/reasons. On the contrary, tax evasion is an illegal activity that involves the use of various techniques or mechanisms for not paying taxes. Individual taxpayers or businesses engage in tax evasion through coming up with various ways not to pay their taxes.

While these individuals or businesses may carry out legal activities, they are liable for tax evasion if their motivation behind the legal activities is to fail paying the taxes they owe. According to Murray (2017), the most commonly utilized techniques by individuals to evade paying taxes include failing to report income, failing to pay taxes owed, and reporting expenses that are not legally permitted. Individual taxpayers also engage in tax evasion through failing to report income from money-making practices in the underground economy.

On the other hand, businesses participate in tax evasion through state sales taxes and employment taxes. Additionally, some businesses engage in illegal practices to evade payment of sales and excise taxes as well as other federal, state, and local taxes (Murray, 2017). An example of a landmark tax evasion case is Gregory v. Helvering case, in which the plaintiff, Ms. Evelyn Gregory, engaged in tax avoidance through treating the transfer of Monitor Securities Corporation's stock by United Mortgage Corporation to her as capital gain on her federal tax return.

Gregory achieved this through promoting the reorganization of United Mortgage Corporation, a company that she owned all its stock and was entitled to obtain dividends from. Gregory facilitated the restructuring of United Mortgage Corporation by complying with all the technical statutory regulations for corporate reorganization. Gregory was entitled to tax benefits through tax avoidance because the transfer of a corporation's stock to its shareholders during a corporate reorganization represents capital gain (Leagle, 1935).

The Supreme Court found Gregory guilty of taxation and ruled in favor of the federal tax commissioner who determined a deficiency in her (Gregory) taxes. Even though Gregory engaged met all technical statutory requirements for corporate reorganization and correctly treated capital gains on her federal taxes, her actions were motivated by tax evasion rather than genuine corporate reorganization. As a result, she was found guilty of tax evasion largely because her actions were driven by illegal motives of failure to pay taxes.

Examples of Tax Avoidance As previously mentioned, there are various techniques through which taxpayers can engage in tax avoidance given the provisions of IRS laws. Some of these techniques that can be utilized for tax avoidance include. Forming a Limited Liability Company One of the most commonly utilized examples of tax avoidance is forming a limited liability company (LLC) in order to limit or lessen personal tax liability.

A limited liability company helps in limiting an individual's tax liability since it acts as a pass-through tax entity and in turn serves as a legal mechanism for tax avoidance. Unlike a corporation, a limited liability company provides an individual or business with significant tax savings. The major advantage of forming a limited liability company to limit personal tax liability is flexibility in taxation.

In this case, an individual can choose whether to be treated as a disregarded entity or obtain corporate treatment during taxation depending on his/her desired personal income and amounts to be reinvested in the business. Both strategies enable the taxpayer to obtain huge tax savings and in turn avoid taxes. The other way through which an LLC can be used to limit personal tax liability is through leasing assets to a corporation.

Leasing personal assets to a corporation enables an individual to create a business expense that can be written off by the LLC and increase his/her income in the process. A suitable example of this is in Niuklee, LLC v. Commissioner (2015) in which Robert Klee, co-founder of Hometown Quotes, LLC, formed Niuklee LLC to buy and lease an aircraft (Leagle, 2015).

Klee formed Niuklee to lessen his personal liability with regards to purchasing and leasing an aircraft after considering his own liability as well as the tax consequences of forming Niuklee to buy and lease the aircraft. Based on the evidence presented in the court, the Supreme Court found that Klee's decision to create Niuklee for the purchase and lease of the aircraft was a legitimate business decision instead of a tax avoidance move.

The court also determined that Niuklee was exempted from paying sales and use tax following its purchase of the aircraft i.e. Cessna C-400. Through this initiative, Robert Klee effectively and legally avoided taxes by forming a limited liability company. Royalty Payments The second example of tax avoidance is through inter-firm royalty payments, which enables businesses to effectively avoid taxes. Royalty payments offer a suitable way for tax avoidance since federal, state and local governments allow deductions for such payments.

The deductions for royalty payments in turn lessens the tax liability to the business given that based on the U.S. tax system, royalty payments are a deductible expense. A suitable example of a court case that demonstrates the legitimacy of using inter-firm royalty payments for tax avoidance is The Sherwin Williams Company v. Commissioner of Revenue (2002). In this case, Sherwin Williams sought to challenge the assessment utilized for 1991 tax year and disallowance of nearly $47 million deducted by the taxpayer from its taxable income for royalty payments.

The company had made the royalty payments to two passive investment firms i.e. Dupli-Color Investment Management Company (DIMC) and Sherwin-Williams Investment Management Company (SWIMC), which was an indicator of inter-firm royalty payments. Since both SWIMC and DIMC were incorporated in Delaware in 1991, they were eligible for exemption from the state's corporate income tax rate (Leagle, 2002). After transferring its legal title to the passive investment companies, Sherwin-Williams obtained trademarks through which it paid royalties.

The court determined that the transfer of the legal title and the license back to Sherwin-Williams was a legitimate business transaction that was not motivated by tax avoidance. Additionally, they found that the transaction involving royalty payments has practical economic impacts as shown by the income earned, investments and obligations of SWIMC and DIMC. Therefore, the royalty payments in this case were legitimate ways of tax avoidance, especially because of their practical economic effect.

Examples of Tax Evasion Similar to tax avoidance, there are several techniques employed by individual taxpayers and businesses to evade taxes. Some of the most common examples of tax evasion practices include the following. Underreporting Income One of the most common ways in which an individual may be found guilty of tax evasion is through underreporting income on their federal income tax returns. Taxpayers engage in tax evasion through underreporting income, which is considered as providing false information to the Internal Revenue Service regarding income or expenses (Murray, 2017).

An individual taxpayer or business underreports income in federal income tax returns in order to limit liability for taxes. However, this means of limiting liability through underreporting income is illegal and constitutes tax evasion. An example of such incidence is in Our Country Home Enterprises, Inc. v. Commissioner of Internal Revenue (2015) case. The case, which involved consolidating seven cases, was to determine federal income tax deficiencies identified by the Commissioner and the accuracy of penalties (Leagle, 2015).

Following an examination of evidence presented before it, the Supreme Court ruled that the petitioners has considerably underreported income on the federal income tax returns for every year under review. The petitioners deliberately engaged in underreporting and were therefore liable for tax evasion. This ruling was made on the premise that the court could not establish the reasonable cause and good faith defense of the petitioners and were therefore liable for the 30% tax evasion penalty imposed by the Commissioner.

Deliberate Under-payment of Taxes The second common example of tax evasion is deliberate under-payment of taxes as a means of limiting tax liability. In this case, an individual taxpayer deliberately underpays his/her taxes with a view of fooling IRS and avoiding high taxation based on his/her income and expenses. However, businesses utilize legal provisions to find mechanisms through which they can underpay taxes owed to the IRS. For instance, in Bank of New York Mellon Corporation v.

Commissioner of Internal Revenue (2013), the Supreme Court examined the Commissioner's deficiencies in the petitioner's federal income tax of $100 million and $115 million for 2001 and 2002 respectively (Leagle, 2013). The Court found that the petitioner's Structured Trust Advantaged Repackaged Securities (STARS) transaction lacked economic substance. Moreover, the U.S. Congress did not plan to grant foreign tax credits for such transactions and is therefore invalid for federal tax purposes.

Therefore, the Supreme Court disallowed the foreign tax credits and expense deductions claimed by the petitioners based on this transaction since it was illegal and constituted tax evasion. Tax Liability Minimization and Tax Avoidance/Evasion Tax liability minimization is regarded as one of the most important strategies of financial planning for individuals and businesses. The process of tax liability minimization can be a complex and confusing one, but basically entails considering tax implications in order to limit or reduce taxes.

During this process, an individual or business considers the taxation implications of his/her individual investments or business decisions. Tax liability minimization has emerged as an important component of tax and financial planning because many legal deductions are unclaimed on an annual basis. Since tax is a huge cost for corporations, tax liability minimization is considered as a suitable measure for enhance profitability (Mgammal & Ismail, 2015).

While tax liability minimization has become an important concept of financial and tax planning, its important to examine whether it falls under tax avoidance or tax evasion. Since tax avoidance involves taking action to lessen taxes and after-tax income, tax liability minimization falls under tax avoidance. This is primarily because tax liability minimization involves using legal strategies and actions to minimize taxes, especially methods approved by the Internal Revenue Service.

Some of the measures utilized in tax liability minimization, which demonstrates that it falls under tax avoidance, include retirement planning and tax savings, deduction planning, lessening taxable income, and investment tax planning. For instance, in Niuklee, LLC v. Commissioner (2015), Klee legally formed a limited liability company as part of his plan to minimize his tax liability. Klee's decision to create Niuklee to purchase and lease an aircraft was found legitimate since it was a legal means for his personal tax liability minimization. In Maguire v.

Commissioner of Internal Revenue (2012), the petitioners were found liable for tax penalties imposed by the respondent since they failed to keep adequate books/records that could substantiate questionable items on their returns. While they claimed deductions for charitable deductions, several adjustments and other transactions, the petitioners could substantiate these claims. The court found them liable for penalties for their failure to substantiate their claims rather than purportedly engaging in the legal measures to minimize tax liability.

Therefore, charitable deductions, adjustments, and other transactions in this case were legitimate tax liability minimization strategies. In conclusion, individual taxpayers and businesses need to engage tax and financial planning including through involving tax advisors. During the planning process, taxpayers need to ensure that their strategies are based on the law in order to avoid taxation issues/challenges. This is primarily because of the concepts of tax avoidance and tax evasion, which are commonly used interchangeably though they are different concepts.

Tax avoidance is a legitimate way of lessening taxes and increase after-tax income through the use of methods approved by the Internal Revenue Service. On the contrary, tax evasion is the illegal practice of failing to pay taxes through various measures such as falsifying information like income and expenses as well as underpaying taxes. As shown in this discussion, tax avoidance is a legal.