What Is the Difference Between Tax Avoidance and Tax Evasion?

While tax avoidance is defined as the legal practice of finding loopholes to lower a tax bill, tax evasion describes illegal methods of manipulating finances to lower a tax bill, notes Christopher Bergin for Forbes. Government bodies, such as the Internal Revenue Service, pursue and prosecute cases of tax evasion but not of tax avoidance.

According to The Economist, one common example of tax avoidance involves businesses setting up foreign-based subsidiaries in low tax countries to pay that country's tax rate rather than the higher rate of the country where their headquarters are located. This method of tax avoidance can become tax evasion if the government proves that the subsidiary exists for the sole purpose of avoiding the higher tax rate. While simply moving money off shore to a foreign bank is not itself an illegal act of tax avoidance, moving the money to avoid declaring income is prosecutable.

As Paul Sullivan for The New York Times explains, the distinction between tax evasion and tax avoidance can be very fine. For example, while people may have legitimate reasons to set up an offshore shell company, those who stock it with undeclared assets cross the line into illegality. According to Bergin, government entities examine a person or company's intent when looking to distinguish between tax avoidance and tax evasion.