Worksheet Solutions
The Difference Between Tax Avoidance and Tax Evasion
Theme 1: Your Role as a Taxpayer
Lesson 3: The Taxpayer’s Responsibilities
Key Terms
tax avoidance—An action taken to lessen tax liability and maximize after-tax income.
tax evasion—The failure to pay or a deliberate underpayment of taxes.
underground economy—Money-making activities that people don’t report to the government,
including both illegal and legal activities.
voluntary compliance—A system of compliance that relies on individual citizens to report their
income freely and voluntarily, calculate their tax liability correctly, and file a tax return on time.
Summary
The U.S. income tax system is based on the idea of voluntary compliance. Under this system, it
is the taxpayer’s responsibility to report all income. Tax evasion is illegal. One way that people
try to evade paying taxes is by failing to report all or some of their income. Sometimes people do
not report income gained through illegal activities such as gambling and selling stolen goods.
Other times they do not report all the tips they collect or the money they earn through legal
activities such as garage sales, baby-sitting, tutoring, or yard work. Such money-making
activities are part of the underground economy, which exists as a way to avoid paying taxes.
If taxpayers fail to pay what officials say they owe, the IRS can assess a penalty, in addition to
collecting the back taxes.
In contrast, tax avoidance is perfectly legal. IRS regulations allow eligible taxpayers to claim
certain deductions, credits, and adjustments to income. For instance, some homeowners can
claim a deduction for interest they pay on a home mortgage. Working parents may be able to
claim a credit for child-care expenses. There are also deductions based on the number of family
members. These are only a few of the many ways people can legally limit the tax they pay.
However, the taxpayer must be able to prove that he or she qualifies. Many people pay more
federal income tax than necessary because they misunderstand tax laws and fail to keep good
records.
Activity 1
Circle each example of tax evasion.
A. keeping a tip log
B. mailing tax forms on time
C. ignoring earnings for pet-sitting
D. keeping accurate and organized records
E. not reporting interest earned on loans
C. ignoring earnings for pet-sitting
E. not reporting interest earned on loans
Understanding Taxes
1