Taj Mahal, the casino once owned by Donald Trump in Atlantic City, USA. (Photo by Tony … [+]
The news is full of stories about conflicts between taxpayers and tax collectors. Just weeks ago, a New York jury convicted the Trump Organization of criminal fraud for a 15-year scheme to help top executives evade taxes. While that case is a linguistic no-brainer, we often struggle to adequately describe those who work aggressively to minimize their taxes.
We tend to use a long list of descriptions almost interchangeably. There is tax avoidance, tax evasion and tax fraud. We describe people and companies as cheats and tax evaders. But what do all these phrases really mean?
The short answer: no one can agree.
And, among other problems, this ambiguity confuses the how we think about the tax gap—the difference between taxes owed and taxes paid.
Think of tax compliance along a continuum. At one extreme are compulsively honest taxpayers who pay every penny they owe (and maybe even some tax they don’t owe).
At the other extreme are cold-blooded tax evaders: drug dealers who don’t report income from their illicit activities, or ordinary business owners who claim a deduction for the family car when they know they’ll never use it for business. they fit legal definition of tax evasion, which is a willful and intentional violation of a known legal duty. Many also call them tax fraud, although the phrase has no legal meaning.
But then there’s a big gray area. That is the home of those who stretch the law as far as they can to minimize their tax liability. Can your tax advisors find a deduction that may be legal, in other words, one that could stand up if challenged? Perhaps they are relying on a novel interpretation of the law or taking advantage of a loophole left open by Congress when it drafted a statute.
Economists and lawyers see this gray area in very different ways.
Economists generally believe that there is a red line that divides the world into two relatively clear concepts: tax avoidance, which is perfectly legal, and tax evasion, which is not.
For them, avoidance is legally minimizing the tax liability. It doesn’t matter how aggressive the taxpayers are or even if they intend to circumvent the law. If the IRS cannot successfully prove that you violated the law, the activity is evasion. Smelly, perhaps, but legal.
Evasion, or fraud, falls on the other side of that line. If these actions are contested, the taxpayer would lose and be found to have violated the law.
But tax professionals don’t think so.. They live in the shadows of that gray area, and many even resist the idea of a clear red line. They write nuanced opinions that can say a deduction is “more likely than not” to succeed if challenged by tax authorities.
If I trust that opinion but it turns out to be incorrect, does that make me a tax evader? A failed tax evader? Or someone who received bad advice?
What if the IRS never contests the deduction? The agency can challenge it on my tax return but not on yours. One judge may find the deduction inappropriate, while another may say it is okay. And, as we’ve seen with Donald Trump’s personal tax returns, it can take years, or even decades, for disputes to be resolved. Is it cheating if you never get caught?
Have you broken the tax laws if the IRS never finds out? If you drive 80 miles per hour in a 55 mile per hour zone, are you speeding even if you don’t get a ticket?
Tax professionals are not allowed advise clients based on their probability of being discovered. But taxpayers can, and do, take this “audit lottery” into account.
A good example of this legal and linguistic ambiguity: former President Trump stated $916 million in net operating losses in the 1990s, despite being told by his own lawyers that his position probably wouldn’t hold up to IRS scrutiny. But there is no public evidence that the IRS has ever challenged Trump’s losses.
Perhaps the IRS overlooked the problem, or quietly settled for pennies on the dollar. But what do we call what Trump did? Was it fraud or tax evasion? Or just extremely aggressive tax evasion?
Let’s end where we started. We all understand what a criminal tax fraud conviction means. But how do we label someone who pays less tax than he ultimately owes? Steve, a tax attorney with 25 years of experience, favors a decidedly non-legal term: tax evader. But given all the ambiguity about non-payment of taxes, nothing fits the bill.
