The news is filled with stories about conflicts between taxpayers and tax collectors. Just a few weeks ago a New York jury convicted the Trump Organization of criminal fraud for a 15-year scheme to help top executives dodge taxes. While that case is a linguistic no-brainer, we often struggle to properly describe those who aggressively work 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 businesses as tax cheats and tax dodgers. But what do all these phrases really mean?
The short answer: Nobody can agree.
And, among other problems, this ambiguity confounds the way we think about the tax gap—the difference between taxes owed and taxes paid.
Think of tax compliance along a continuum. At one end are compulsively honest taxpayers who pay every dime they owe (and perhaps even some tax they don’t owe).
At the other end, there are stone-cold tax evaders: drug dealers who fail to report income from their illicit activities, or ordinary business owners who claim a deduction for the family car when they know they never use it for business. They fit the legal definition of tax evasion, which is a voluntary, intentional violation of a known legal duty. Many also call them tax cheats, although the phrase has no legal meaning.
But then there is a big gray area. That’s the home of those who stretch the law as far they possibly can to minimize their tax liability. Can their tax advisers find a deduction that may be legal, in other words one that could be sustained if challenged? Perhaps they are relying on a novel interpretation of the law or driving through a loophole Congress left open when it wrote a statute.
Economists and lawyers look at this gray area in very different ways.
Economists generally believe there is a red line that divides the world into two relatively clear concepts: tax avoidance, which is perfectly lawful, and tax evasion, which is not.
For them, avoidance is legally minimizing tax liability. It doesn’t matter how aggressive taxpayers are or even whether they intend to sidestep the law. If the IRS cannot successfully prove they violated the law, the activity is avoidance. Odorous, perhaps, but legal.
Evasion, or fraud, falls on the other side of that line. If these actions are challenged, the taxpayer would lose and be found to violate the law.
But tax practitioners don’t think like that. They live in the shadows of that gray area and many even resist the idea of a clear red line at all. They write nuanced opinions that may say a deduction is “more likely than not” to succeed if it is questioned by tax authorities.
If I rely on such an opinion but it turns out to be wrong, does that make me a tax cheat? An unsuccessful tax avoider? Or somebody who got bad advice?
And what if the IRS never challenges the deduction? The agency may contest it on my tax return but not on yours. One judge may find the deduction improper, while another may say it is just fine. And, as we’ve seen with Donald Trump’s personal tax returns, it may be years, or even decades, before disputes are resolved. Is it cheating if you never get caught?
Have you failed to comply with the tax laws if the IRS never notices? If you drive 80 miles an hour in a 55 mile an hour zone, are you speeding even if you don’t get a ticket?
Tax practitioners are not permitted to advise clients based on their likelihood of being found out. But taxpayers can, and do, take this “audit lottery” into account.
A good example of this legal and linguistic ambiguity: Former President Trump claimed $916 million in net operating losses in the 1990s, even though his own lawyers told him that his position would not likely stand up under IRS scrutiny. But there is no public evidence that the IRS ever challenged Trump’s losses.
Perhaps the IRS missed the issue, or quietly settled for pennies on the dollar. But what do we call what Trump did? Was it tax fraud or evasion? Or merely, extremely aggressive tax avoidance?
Let’s end where we started. We all understand what a conviction for criminal tax fraud means. But how do we label somebody who pays less tax than they ultimately owe? Steve, a tax lawyer with 25 years of experience, favors a decidedly non-legal term: tax dodger. But given all the ambiguity over non-payment of taxes, nothing fits perfectly.