The difference between tax evasion vs tax avoidance is something that often comes up in conversations with clients.
If you’re serious about your taxes as a remote worker, you need to understand the difference.
The Difference between Tax Evasion and Tax Avoidance
Tax evasion and tax avoidance have the same objective: paying less taxes.
Yet, the way you get there differs. Basically, tax evasion does this in an illegal way while tax avoidance is legal.
Definition of Tax Avoidance
Tax avoidance is avoiding taxes in a legal and compliant way.
An example will help you understand the concept better.
Example of Tax Avoidance
Let’s say that today you are a tax resident in a high-tax country.
In order to avoid the high tax burden, you decide to become a tax resident in a country with lower tax rates and adjust your lifestyle accordingly.
In the above example, if you are no longer a tax resident in the high-tax country, you avoid paying taxes there. If everything is set up properly, this is a perfectly legal way to reduce your taxes.
So, tax avoidance is simply avoiding taxes in accordance with the laws and doing legal tax planning.
Definition of Tax Evasion
Tax evasion is avoiding the application of the tax laws on to your income by setting up schemes to hide your income (1).
That’s it, nothing more and nothing less, as easy as that.
An example will make this clear.
Example of Tax Evasion
Let’s say you are a tax resident of a country where you need to declare your worldwide income.
Nevertheless, you decide not to declare the income you received in an offshore account because you think your local tax authorities won’t find out.
You are now leaving reportable income out of your tax return. Therefore, you are committing tax evasion.
This means you are simply breaking the law.
It goes without saying you don’t want to get involved with tax evasion.
Summary: tax evasion is illegal income concealment and you should stay away from it.
Legal Consequences and Penalties for Tax Evasion
The first consequence you’ll face when the authorities find out about tax evasion is that you’ll have to pay the taxes which were due in any case.
Yet, the authorities will also claim interest on this amount. The reason is that you will only pay the amount later than when it was actually due if you had followed the law.
In addition, you can also expect to receive penalties depending on the gravity of your offense.
In most cases, you’ll have to pay a fine on top of the aforementioned amounts. Nevertheless, in case of very serious crimes, you could even end up with criminal charges leading to imprisonment. Probably not something on your bucket list.
How do Countries Monitor Tax Evasion?
Countries have various ways to combat tax evasion:
- Tax audits: the tax authorities will do tax audits on individuals and companies whereby they’ll look into your financials in detail.
- International exchange of information: most countries around the world these days will exchange information with each other so they can get a full picture of your situation, even if you have an international lifestyle and setup.
- Data mining: also tax authorities are improving their digital capacity. By putting all information they get together the system will spit out any risk cases they need to take a look at.
- Artificial intelligence: in this respect, governments are also more and more using AI to assist them with processing all this information.
How to Reduce Taxes Staying Within the Law
Changing your tax residency in line with the applicable tax laws is probably the easiest way to reduce taxes as a digital nomad.
Let’s say you are making €5.000 per month and are currently paying a (fixed) tax rate of 30% on that. That means that at the end of the month, you have €3.500 left.
If you’d move to a jurisdiction with a tax rate of 10% instead of 30%, your disposable income at the end of the month will spontaneously jump to €4.500 or a €1.000 more.
Probably the easiest way to give yourself a raise without putting in additional hours.
Most people living a ‘traditional’ live won’t have too much options in order to use tax avoidance to their advantage as they aren’t as flexible as digital nomads.
This flexibility comes with more options if structured properly. Again another benefit of the digital nomad life.
The above is just one of the examples on how tax avoidance can help digital nomads decrease their tax burden.
Work With Me and Reduce Your Tax Burden Legally
If you want to avoid taxes in legal and compliant way you can reach out to me!
Over the years, I have assisted hundreds of digital nomads improve their tax setup without them risking getting into trouble with the tax authorities.
FAQ
Let’s now have a look at some Frequently Asked Questions regarding tax evasion vs tax avoidance.
What is the Most Common Tax Avoidance?
The most common tax avoidance is changing tax residency.
When you are not happy with the taxes in your current country of tax residency you can simply pick up your stuff and move to another country.
Many people make such a change to move to a country with a better lifestyle but you can also do it to improve your tax situation.
Which Is Worse, Tax Avoidance or Tax Evasion?
Tax evasion is definitely worse than tax avoidance.
Tax evasion is trying to escape taxes in an illegal way. Therefore, you don’t want to get involved with this.
Tax avoidance, however, is perfectly legal so you want to focus on tax strategies that fall within the scope of tax avoidance.
What is the Harshest Penalty for Tax Evasion?
The harshest penalty for tax evasion is imprisonment.
Now, let’s be clear here, this is probably not a penalty the average person should be afraid off. However, if you’re systematically setting up systems to do so on a larger scale you might get in serious trouble.
Which Tax is the Most Difficult to Evade?
The hardest tax to evade is probably Value Added Tax or VAT.
Yet, you probably don’t want to get involved with evading taxes in any case as this illegal. You better have a look on how to avoid taxes instead.