Tax Evasion vs. Tax Avoidance

Last month, rapper and producer Earl Simmons, commonly known as DMX, was caught Slippin’ as he pleaded guilty to tax fraud at a court hearing in Manhattan, New York. For nearly half a decade, the rapper has grossed millions of dollars from his hit recordings, television appearances, and other varied royalties. It is alleged that over this five year period, Simmons has evaded roughly $1.7 million of income tax liabilities, and the IRS decided it was time for DMX to Stop Being Greedy. Mr. Simmons now owes the full $1.7 million tax bill to the IRS, and his November 30^th guilty plea carries a maximum sentence of five years in prison. When DMX released X Gon’ Give It To Ya, something tells us he was not referring to $1.7 million in past due taxes.

While DMX actively evaded his tax responsibility, which is illegal, every taxpayer is entitled to avoid as much tax as possible. The distinction between tax evasion and tax avoidance is not a simple matter of law, but a question of facts and circumstances. Tax avoidance strategies use legal means of adjusting one’s financial situation to reduce or defer income tax liabilities, whereas tax evasion is the purposeful concealment of income to thwart the revenue-collecting arm of the Treasury. From 2000 through 2005, it was alleged that DMX engineered a scheme to systematically evade his income tax responsibility by insisting to be paid in cash and arranging for royalty payments to be deposited into the accounts of multiple managers, associates, and other financial surrogates. The United States Attorney’s Office reported that Simmons listed a mere $10,000 of income for 2013, when in fact, he earned hundreds of thousands of dollars that year. These actions, taken as a whole, illustrate a plain example of tax evasion.

There are two important guidelines, Constructive Receipt and Assignment of Income, that can help you identify situations in which you might be in receipt of taxable income and required to report it on your tax return. Constructive receipt provides for when income becomes taxable, and assignment of income dictates to whom the tax liability belongs.

1. The doctrine of constructive receipt is a concept used to determine when an individual is in receipt of taxable income. As individuals, we pay tax on our earnings in the year in which they are received or constructively received. Receipt does not necessarily mean that earnings are deposited into an individual’s bank account; constructive receipt refers to when individuals have unfettered control over amounts set aside for them. The aim of this doctrine is to prevent individuals from improperly shifting income into the future and evading the proper tax today.
2. The assignment of income doctrine is intended to prevent the splitting of income among various taxpayers. In other words, the concept aims to ensure that the individual, who actually earns the income, pays the tax due on that same income. Instructing for funds to be deposited in the accounts of financial surrogates to evade reporting obligations violates this basic principle.

As 2018 begins, and all individuals will be assessing their 2017 tax positions in the coming weeks, it is paramount to be aware of compliance obligations for the year. Tax liabilities do not cease to exist simply because they are not properly reported, and ignored debts can only worsen. Underreporting of taxable income can carry a substantial penalty of twenty percent of the understated tax liability. Addressing an outstanding tax bill head-on generally yields a better outcome than if the Internal Revenue Service discovers it down the line.

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