Question

ACC312 Federal Taxation

Tax avoidance/Tax evasion

For each of the following situations, discuss whether the individual is engaging in tax avoidance or tax evasion.

a. Mr. L performed minor construction work for a number of people who paid him in cash. Because Mr. L knows that there is almost no chance that the IRS could learn of these payments, he reports only half the payments as income on his federal tax return.

b. Mr P, who is in the 39.6 percent tax bracket, recently had the opportunity to invest $50,000 in a new business that should yield an annual return of at least 17 percent. Rather than invest himself, Mr. P gave $50,000 cash to his son, who then made the investment. The son's marginal tax rate is only 15 percent.

c. Mrs. Q sold an asset during January. Her $12,000 profit on the sale is ordinary income. After preparing her income tax return for the prior year, Mrs. Q realized that her marginal tax rate for that year was 28 percent. She also realized that her marginal rate for this year will be 39.6 percent. Mrs. Q decides to report the profit on her prior year return to take advantage of the lower tax rate.

Answer 1

Answer

A. Mr. L is engaging in tax evasion because he is deliberating understating income (and thus his tax liability)for the year.

B. Mr. P is engaging in tax avoidance. He has not earned any income that he fails to report. Instead, he isgiving his son an opportunity to earn income that will be taxed at a lower marginal rate than if Mr. Pearned it.

C. Mrs. Q is engaging in tax evasion because she is deliberately violating the rule requiring taxpayers toreport and pay tax on income in the proper year. She is filing her prior year return based on falseinformation (the year of sale).