Tax avoidance vs. tax evasion

June 1, 1999
hen it comes to taxes, a fine line separates right from wrong. That difference boils down to tax avoidance vs. tax evasion.

Hugh F. Doherty, DDS, CFP

hen it comes to taxes, a fine line separates right from wrong. That difference boils down to tax avoidance vs. tax evasion.

Tax avoidance involves using methods permitted by law, such as deferral of income in a qualified retirement plan; allowable tax deductions such as medical and disability insurance, cafeteria plans, expensing your car, etc.; and methods for reducing tax liabilities for the current year. A successful tax-avoidance strategy involves properly interpreting the laws. Misjudging the rules may result in interest penalties and payment of taxes owed.

Tax evasion, by comparison, falls on the wrong side of the boundaries. Evasion involves deceit, concealment, subterfuge, or other methods to obscure events. If uncovered, tax evasion carries heavy penalties, including potential fines and prison time. Best advice: Incorporate. Become an employee so you can pay your taxes and pay them on time.

Office repairs and improvement

If you plan to make extensive improvements to your office, and you also want the contractor to do some repairs, you should, for tax reasons, request separate bills for the different kinds of work.

Expenses for repairs that keep your office in normal, efficient operating condition (for instance, patching minor damage to fixtures or repainting walls) are deductible on your return for the year that you incur them. But improvements that add to your property`s life or value (for instance, replacing the roof or enlarging your reception room) must be depreciated, so recovering their cost takes years.

When you contract for both types at the same time, the IRS could consider all the work to be a single improvement project and require you to depreciate the entire cost. To forestall such a problem, figure out which category each job falls into. Then have the contractor submit one proposal for all those you have designated as repairs and another for the improvements.

Audits of retirement plans

If you don`t use the right expert, it could cost you thousands of dollars and possibly destroy your retirement.

Suppose the Internal Revenue Service notifies you that it intends to audit your retirement plan. If you are like many doctors, you will run to the phone and call your accountant. Should you? The answer is a resounding, "No!" Using an adviser such as an accountant who has little experience at plan audits could be an expensive mistake. You want somebody who has done at least 10, and ideally more, audits. A retirement-plan audit is very different from one on a tax return. There are distinct ways to negotiate, specific points to argue, and a whole structure of fines, sanctions, and moves to be acquainted with. The ins and outs of an audit on a retirement plan, the procedures, and the rules are a distinct subspecialty. There is a lot to know.

In a personal tax audit, the IRS agent says, "OK, I will allow 60 percent of the car expenses, but you will have to cut back on those entertainment write-offs." Usually, both sides expect give-and-take and work things out.

A retirement-plan audit is more like an examining table than a bargaining table. The agent gives the plan a checkup, comparing it against specific standards and the complex qualified-plan rules. If the plan doesn`t pass, the agent lets you know you have a problem.

And that`s where an inexperienced adviser often takes the first wrong turn. First, he/she might try to win on technicalities. In general, that is pointless. The IRS agents have the rules and regulations down cold. Many accountants and attorneys have found that in income-tax audits, being forceful can help. But that can backfire disastrously in retirement-plan audits. So, you ask: "If plan-audit questions are cut and dried, is there really room to negotiate?" Plenty, if your adviser knows where to focus; and it`s not on the violation, but on the sanctions imposed.

Consider using only an experienced adviser therefore. Your plan administrator (actuary), who has supervised 100 percent of plans, is best equipped to handle your situation.

Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession, and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, contact him at (800) 544-9653. E-mail: [email protected]. Web site: