Tax Avoidance vs. Tax Evasion: What Business Owners Need to Know

Tax avoidance means legally minimizing your tax obligation through allowable deductions, credits, and strategic planning that prioritizes tax advantages. Almost every taxpayer practices tax avoidance by taking the credits and deductions that are legally allowed to them. In fact, there are many credits and deductions built into the IRS code to benefit certain taxpayers and incentivize certain behaviors.

Tax evasion, on the other hand, is a criminal activity that involves illegally underpaying a true tax obligation through falsifying or failing to report information. Tax evasion can land a taxpayer with a penalty, jail time, or both.

Credits for alternative energy, charity, retirement savings plans, childcare, and education are all legal and allowable credits designed to encourage certain behaviors or benefit taxpayers. These are examples of tax avoidance built into the tax code. Providing tax advice to help clients minimize their tax obligations is a major industry in the United States. Examples of illegal tax evasion include failing to report all sources of income and knowingly inflating business expenses.

Material error on a tax return

What about a third scenario—when a business aims for compliance with all IRS regulations but ends up with a material error on a filed return? What should you do to prevent a legitimate error from being considered outright fraud or tax evasion?

Due to the complexity of the tax code and the human involvement in tax return preparation, it is inevitable that sometimes material errors will occur on a tax return and will first be noticed after filing. In certain cases, a material error is cause for filing an amended return with the IRS.

When should you file an amended return?

You don't need to file an amended return if:

• You made a mistake in computation. The IRS will make the changes and mail you a notice with the amount of the payment due, along with any interest and penalties. You may be entitled to a refund, in which case the IRS would similarly notify you.
• You forgot to attach the forms. The IRS will request them from you.

You should file an amended return for any change that alters your tax liability. This includes changes in filing status, income, deductions, or credits. Here are some common situations where an amended return would be called for:

• You claimed an incorrect filing status or filed the wrong business return
• You neglected to report a source of income
• You did not claim a deduction or credit that you were eligible to claim
• You claimed a deduction or credit that you were not eligible to claim
• You need to change your reported dependents (personal return)

In these cases, where there is additional information and a significant change to your tax liability, you would need to alert the IRS by filing an amended return.

Filing an amended return

For any amendment that you need to file, wait until the original return is filed and any refund due is received before filing an amendment. To receive a refund or credit, you must file an amendment within three years after the date you filed the return, or two years from the date that you paid the tax for that return, whichever is later.

If you are filing amendments for multiple years, keep each amendment separate by year.

Changes made to your return through an amendment have a flow-through effect. For example, a change in income may cause a change in certain deductions taken. For this reason, it is important to have a tax professional work with you to make sure the amendment fully corrects all aspects of the original return.

Use the following forms to file an amendment for your business:

• Sole proprietor or single member LLC: Form 1040-X, including any changes to Schedule C
• Corporations: Form 1120-X
• S-corporations: Form 1120-S
• Partnerships and multi-member LLCs: Form 1065-x

While filing an amendment seems like a lot of effort after you've already done your best to file taxes, having everything reported correctly will only serve your business well in the future, particularly in the case of an IRS audit.