Imagine you’re standing in a big kitchen, getting ready to cook a tax-saving feast. On one counter, you have tax avoidance ingredients—things the government says are perfectly fine to use. On the other counter, you have tax evasion ingredients, which are more like a bottle of shady sauce you’re not supposed to touch. One is legal; the other can land you in hot water and up to five-years in prison.

Let’s dish up the main differences:

Tax Evasion: The Celebrity Examples

If tax avoidance is following the official cookbook, tax evasion is like scribbling fake recipes in the margins and hoping no one notices. It involves intentionally breaking the rules.

• Richard Hatch (Not Reporting Income): The season 1 winner of “Survivor”, Richard Hatch was convicted of not reporting the $1.43 million in income received for winning in 2000.  He spent more than 4 years in prison upon the conviction of tax evasion. His sentencing was enhanced for obstruction of justice.
• Martha Stewart (State Residency Fraud): In 1994, more than a decade before the insider trading scandal would send her to prison, Martha Stewart paid more than $220,000 in back taxes and penalties.  As reported by the New York Times, the state won a dispute after the media starlet claimed residency in Connecticut, but auditors found that she spent more than half the year living in New York.
• Wesley Snipes (Failure to File): The “Blade” movie star didn’t file any tax returns from 1999-2001 according to People, resulting in $41 million in tax debt. Snipes, was so bold as to file claim to a $7 million refund, which could have resulted in multiple felonies of conspiracy to defraud the government and filing a false claim.

Unlike legal tax avoidance, tax evasion can lead to heavy fines or even prison time. It’s wrong and definitely not worth the risk!

Tax Avoidance: The “Recipe-Approved” Ingredients

1. Maximizing Your 401(k)

• Why it’s legal: This is a retirement account where you can put money away before taxes are taken out. It grows tax-deferred, meaning you don’t pay taxes on the money until you withdraw it later in life.
• Example: Imagine putting chunks of your paycheck into a piggy bank marked “Retirement.” The government says, “Nice job saving!” and rewards you with a smaller tax bill now.

2. Non-Qualified Deferred Compensation

• Why it’s legal: Some companies let high earners set aside part of their salary to be paid in the future. You usually don’t get taxed on that money until you actually receive it years down the line.
• Example: Think of it like a time capsule full of money you bury today and plan to dig up (and pay taxes on) later—maybe when you’re in a lower tax bracket.

3. Investing Your HSA

• Why it’s legal: A Health Savings Account (HSA) is meant to help pay medical costs. You can contribute pre-tax dollars, and if you invest those contributions, any growth is also tax-free if used for qualified medical expenses.
• Example: Imagine you have a special first-aid piggy bank that not only holds money but grows it too. As long as you use that money for medical needs, you won’t have to share any with Uncle Sam.

4. Mega Backdoor Roth Contributions

• Why it’s legal: With this strategy, you contribute after-tax money to a 401(k) and then roll it into a Roth IRA, where it can grow tax-free.
• Example: Think of a hidden passage in a castle. You walk through the “mega backdoor,” and once you’re inside, the money you bring along gets to grow without being taxed in the future. Boom—more golden eggs for your retirement nest!

5. 351 Exchange of Stock Position

• Why it’s legal: With this strategy, you contribute after-tax money to a 401(k) and then roll it into a Roth IRA, where it can grow tax-free.
• Example: You have a concentrated stock position from company stock and a few other picks.  You would like to diversify your position, but selling would result in taxes.  Instead of selling, you exchange several of your positions including some company stock into a diversified holding resulting in no tax bill due now because you didn’t sell, you exchanged.

6. Rental Property to Real Estate Investment Trust

• Why it’s legal: With this strategy, you take an unwanted rental property and instead of selling it and paying the taxes, you can exchange it into a Real Estate Investment Trust.
• Example: You exchange from one property to another using a qualified intermediary to free yourself of the landlord hassles of the 4 Ts: tenants, taxes, toilets and trash.  Instead you end up with diversified holdings of rental properties and receive a monthly or quarterly check. This allows you to sell shares over time and realize capital gains on your schedule instead of all at once.

7. Charitable Gifting

• Why it’s legal: The government wants to encourage good deeds. When you donate to a qualified charity, you can often write off part of that donation on your taxes.  If you give property that was acquired at a lower price than the value of the gift, you get to deduct the fair market value of the gift.
• Example: You give an asset to help the blind that you acquire for 20 cents on the dollar. The charity uses that asset to help the blind get around by themselves.  Win-win!  The key thing is to find an appropriate property that is used with the purposed of the charity and acquire and donate it.  Make certain to get a qualified appraisal and acknowledgement from the charity of the gift (Works best for those with income over $500k/yr).

All these strategies are kind of like flipping through the official cookbook of tax laws and picking out the best recipes for saving money. You’re following the rules exactly, and the government approves.

Final Takeaway

Think of taxes like a game of hide-and-seek: Tax avoidance is telling your teammates where you’re hiding and playing by the rules; tax evasion is sneaking into a locked closet so no one can find you (and if they do, you’re in big trouble).

So, go forth and use those legal tax-saving tricks—like charitable gifting, maximizing your 401(k), stashing money in a Health Savings Account, or rocking those mega backdoor Roth contributions. Just make sure your recipe is straight from the official cookbook, and you’ll avoid adding any “shady sauce” to your mix!

Need Personalized Guidance?

Tax planning is part of Farther’s Comprehensive Wealth Management. We can help you estimate your 2024 (and beyond) tax liability, plan your withholdings or estimated payments, and incorporate these steps into a broader financial strategy. Feel free to schedule an introductory call to learn how we can support you.

Nathan Brown, CFP®, MBA

Disclaimer

Farther is a Fee-Only wealth management firm based in Lake Oswego, OR. The firm offers comprehensive financial planning, tax planning and investment management to high earning families across the country.

Farther is a Registered Investment Advisor with the State of Oregon. This information is provided as a guide to assist you in your financial planning. The specific examples are provided for illustration purposes only and are not representative of specific investments or guarantees of future returns. Please consult a professional for specific questions regarding your situation.

This publication is for informational purposes only and is not intended as tax, accounting or legal advice or as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company security, fund, or other securities or non-securities offering. This publication should not be relied upon as the sole factor in making an investment decision. Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested.