What Is Tax Avoidance?

How tax avoidance works

Tax avoidance refers to strategies that can help taxpayers legally owe less in personal or business income taxes. This process involves taking actions that allow taxpayers to claim as many credits and deductions as possible on tax returns.

“Common tax avoidance strategies include donating appreciated assets instead of cash, Section 179 expense for business equipment purchases, and Roth conversions to pay taxes in years when your income is lower,” said Jacob T. Rothman, a financial advisor at Rothman Investment Management.

Tax avoidance strategies follow tax laws that are put in place to help encourage certain actions, such as investing or pursuing higher education. Tax laws are created in Congress and signed into law by the president.

The U.S. Internal Revenue Code (IRC) is extremely complex, as many layers of tax laws have been added or amended over the years. This makes it difficult for average Americans to take advantage of many tax avoidance strategies. Finding a licensed tax professional to assist with personal and business taxes can help you get the most out of the tax laws in place.

Common tax avoidance strategies

Some common examples of tax avoidance are:

• Claiming the child tax credit
• Contributing to a traditional IRA
• Deducting medical expenses
• Investing in tax-free municipal bonds

Tax avoidance vs. tax evasion

“Tax avoidance is simply using the tax rules to plan your actions for paying only the minimum tax due,” said Rothman. “Tax evasion is illegally hiding income to make your tax bill less than what your actual income would generate according to the law.”

The tax avoidance examples we cited above, including claiming the child tax credit and contributing to a traditional IRA, are perfectly legal and allowed by the U.S. tax code.

By contrast, tax evasion is a crime that involves hiding your actual tax liability from the government.

Some examples of tax evasion are:

• Falsely claiming children who aren’t your dependents
• Underreporting your income
• Hiding interest or dividends earned from investments
• Deducting personal expenses through your business

Because tax evasion is illegal, these acts can be prosecuted as criminal charges. This could lead to substantial penalties and fees or even jail time.

Legal consequences of tax evasion

Individuals convicted of tax evasion may have to pay a fine of up to $100,000 (this penalty is up to $500,000 for corporations convicted of tax evasion), spend up to five years in prison, or both.

Ways to legally avoid taxes

Paying taxes is part of being a U.S. citizen, but the tax code incentivizes certain actions. There are several ways to legally avoid paying extra taxes. Here are a few of them:

Standard or Itemized Deductions

The U.S. tax code allows you to deduct a certain amount each year, depending on your family size. This is known as the “standard deduction,” and since 2017, this amount has been significantly lowering taxpayers’ taxable income.

For tax year 2025, the standard deduction (the amount you can claim to reduce your taxable income) is:

• $15,750 for single filers (including married filing separately)
• $31,500 for married filing jointly (or qualifying surviving spouse)
• $23,625 for head of household

You can also choose to itemize your deductions, meaning you can keep receipts for expenses incurred throughout the year and input those into your tax return. If the total expense amount exceeds your standard deduction, you can save even more on taxes.

Examples of expenses you can itemize include:

• Home mortgage interest
• Real estate taxes
• Medical expenses (over 7.5% of adjusted gross income)
• Capital losses
• Sales or personal property taxes
• Charitable donations

Retirement contributions

Contributing to certain retirement accounts will allow you to deduct contributions and lower your taxable income. Workplace retirement accounts, such as a 401k or 403b, or an individual retirement account (IRA) allow you to deduct contributions from your taxable income.

You can also contribute to small business retirement plans, such as a SIMPLE, a SEP IRA or a Solo 401(k) account. These lower your taxable revenue in the business and can save a lot of money in taxes.

If you invest in a “traditional” retirement account, you can deduct the contributions from your taxes in the year you make them. If you invest in a “Roth” retirement account, you can’t deduct your contributions, but you can withdraw the funds tax-free in retirement.

All of these retirement strategies are a form of tax avoidance.

» MORE: What is an IRA?

Tax credits

In addition to tax deductions, you may qualify for tax credits, which reduce the taxes you owe. Tax credits can have a better impact than deductions because, while deductions lower your taxable income, tax credits actually reduce what you owe or increase your refund.

Some examples of tax credits include:

• Earned income credit
• Child tax credit
• Education credit
• Saver’s tax credit
• Energy efficient vehicle credit

Running a small business

If you own a small business, you have more deductions available to you than most taxpayers. This is mainly due to your ability to use your home or vehicle for business purposes and write off the expenses.

If you work from home or use an office space in your residence, the home office deduction allows you to deduct a portion of your mortgage, taxes, and utilities against your business income. You can also deduct a vehicle you use for work, either mileage or the cost of the vehicle itself.

Small business owners pay higher taxes than many other people, as they pay additional self-employment taxes that W-2 employees don’t. However, the amount of available deductions can help them reduce their overall taxes.

Owning real estate

Owning real estate offers quite a few tax deductions, including mortgage interest, taxes, repairs and improvements. In addition, rental real estate owners can depreciate the home based on the price paid (plus any improvements), giving real estate owners a potentially massive tax deduction.

On the personal real estate side, homeowners can qualify for a capital gains exclusion on the sale of a personal residence — up to $250,000 for a single homeowner or $500,000 for those married filing jointly. So, if you sell your home for a massive gain, you might not owe any taxes on that income.

Offshoring

Offshoring is the process of individuals or businesses moving their assets to another “tax-friendly” country to avoid certain taxes. While there’s a fine line between offshoring tax avoidance and tax evasion, loopholes in the U.S. tax code allow offshoring to happen legally.

FAQ

Bottom line

Tax avoidance is a legal approach to lowering your income tax burden. You can take advantage of tax deductions and credits to reduce what you owe or even boost your tax refund. However, the U.S. tax code is complicated. It’s a good idea to work with a licensed tax professional to prepare your tax return and ensure that you can legally take advantage of the tax avoidance strategies available to you.