The Panama Papers!
You’ve maybe read about them in the news. You know it has to do with rich people and taxes (doesn’t everything?). You know that the prime minister of Iceland had to resign over it. You know that David Cameron has some ‘splainin’ to do about his family’s involvement. You assume that it has something to do with Panama.
And...that’s about all you know.
It basically comes down to a whole lot of people hiding a whole lot of money in places they don’t want it to be seen. And it’s all illegal, right? This is a clear case of tax evasion! Law enforcement across the globe is going to swoop in and make an unprecedented number of arrests!
Not exactly. Aside from rich people getting arrested being a really funny joke, there’s a lot of money being hidden offshore, but that doesn’t necessarily mean it’s illegal.
It’s all comes down to the difference between tax evasion and tax avoidance.
Tax avoidance vs tax evasion
Tax avoidance is doing what you can to lower your effective tax rate. When you claim a mortgage deduction or a dependent – which means you pay less tax – that’s what you’re doing. And not only is that allowed and perfectly legal, but it’s encouraged. Tax preparers like H&R; Block build their entire business on the premise that they can save you more money than you’d be able to on your own.
Tax evasion is illegal, and it’s when you do things under the table to make sure you don’t have to pay taxes. It’s a form of tax fraud. We’ll get to some specific types of evasion in a bit, but it’s good to know that just because you’re not paying all of your tax doesn’t mean you’re a criminal.
Any easy way to understand this is looking at the recent report that corporations stashing their money in tax havens are costing the United States $100 billion in tax revenue. And these aren’t no-good companies you’ve never heard of; they’re Apple and Walmart and the like.
Were these companies committing tax evasion, they’d be, for instance, lying about how much money they made to hide it from Uncle Sam. But the U.S. government knows what the corporations are doing, and it’s legal to keep money overseas and out of the reach of the IRS.
Is it shady and hypocritical and just enough to make your blood boil a little?
Sure, but it’s also above board and it lowers their tax rate by nearly 10%, so of course they’re going to do it.
The Mastermind scale of tax evasion
We don’t all have teams of lawyers and accountants whispering all of the best tax loopholes into our ear. Sometimes we just have to roll up our sleeves and do the best we can to keep the most money we can.
Have you exhausted the legal avenues for lowering your taxable income through tax avoidance? Here’s how you could evade taxes, along with a handy scale for where you’d rank amongst criminal masterminds.
Disclaimer: It probably goes without saying, but don’t commit tax evasion. Seriously. There are a ton of ways to claim legit deductions and owe very little (or even get a refund!) so you don’t have to stoop to this level. You’re better than that.
Claiming false deductions and credits
The easiest way to lower your tax bill is through various deductions – like charitable donations and mortgage payments – or credits like the Earned Income Tax Credit.
Because there are so many opportunities, it’s possible for anyone to claim a deduction or credit they shouldn’t really get. It could range from claiming a child you don’t actually have to a donation you didn’t actually make.
However, freelancers have even more chances to bend the truth than the rest of us. Freelancers can claim a lot of the same deductions as everyone else, plus a whole lot more. Travel expenses, home office costs, work supplies, and more are all eligible for deductions.
So maybe you fudge the size of the room you use for your office, or you say that that fancy dinner with your girlfriend was really with a client, or that roadtrip you took was to an event. Suddenly you have a lot you can deduct – but if the IRS comes calling looking for receipts, you’re in trouble.
Mastermind level: Frustrated freelancer
A (very) simplified explanation of how your taxes are calculated goes like this: the amount of tax you pay depends on the amount of money you make; make less money and you owe less tax.
But no one wants to actually make less money. They want to make it look like they make less money. And the easiest way to do that is by just saying that you make less money!
Underreporting income is popular among people who work in cash, like members of the service industry. It’s a lot harder for the IRS to track cash than it is a paycheck, so it’s easier for taxpayers to say that they got $300 for a gig instead of the $500 they actually pocketed. But with the right resources, the wealthiest among us could move some money around to make it look like they don't have quite as much.
This is what a lot of people expect (hope?) to find in the Panama Papers. They want to see Richie Rich hiding an extra million overseas that he never told the government about. That hasn’t happened yet – we’re still mostly in the realm of "unfortunate and embarrassing but not really illegal" as far as revelations go – but there could be more coming, so stay tuned!
Mastermind level: Somewhere between a bartender hiding tips and a potential leading role in the Panama Papers
If you’re like the guys in Office Space, you might not know what money laundering is without the help of a dictionary. Basically, it’s passing off illegally-gained money as legitimately-earned money so that the authorities don’t realize that you’re doing illegal things.
Here’s the IRS’ definition (since we aren’t using a dictionary):
...money laundering is the means by which criminals evade paying taxes on illegal income by concealing the source and the amount of profit. Money laundering is in effect tax evasion in progress.
Obviously, if you’re, say, Walter White, you don’t want people knowing that you’re making all of your money from selling meth. So you buy a car wash from Bogdan and pretend that the money is from washes, waxes, and vacuum cleanings. (Spoilers for Breaking Bad, by the way.)
But here’s the problem: all income is taxable, even if it’s illegal. That’s how Al Capone got arrested, after all. So by laundering money you’re evading the taxes on that original income and committing a crime while trying to hide the fact that you committed a crime.
Criminals just can’t catch a break, can they?
Money laundering is often done through shell companies or fronts, which, in this case, exist only to process "business transactions."
Mastermind level: Heisenberg