White and Gray: Navigating Ambiguous Tax Terrain

Taxes were biting viciously into Michoel Friedman’s income. A friend who seemed pretty savvy laughed in Michoel’s face when asked about the topic. “Just don’t pay it,” he said. “A lot of my customers pay in cash. And I use my business credit cards to pay for my household purchases. It’s simple: no profit, no taxes.”

Michoel was astounded at this brazenness and knew that illegal tax evasion wasn’t the way to go. But how could he legally lower his tax bite?

What’s the balance between illegality and handing the IRS a blank check?

Underpaying or Overpaying

Back in September of 2021, I wrote an article explaining that fraudulence such as tax evasion is a bad way to live your life for practical reasons, on top of the illegality and halachic prohibitions involved. But that doesn’t mean people shouldn’t aggressively research and pursue legal tax avoidance. Evasion and avoidance are legally, technically, and practically worlds apart. Many powerful tax avoidance strategies aren’t even complicated, yet many don’t use them for lack of knowledge and proactive planning. This is a complete bal tashchis, leading them to overpay taxes.

Letter of the law

The fundamental theme of US tax law is that it’s fiendishly complicated. The law is voluminous and ambiguous, so it’s very difficult in many scenarios to know exactly what’s owed. Some sections of the tax code is so vague that accountants, tax lawyers, and even IRS agents don’t know with certainty where the black and white lines lie. Tax compliance requires navigating the vast expanses of gray ambiguity and separating the white and black. The white should be vigorously embraced, the clear illegality of black territory studiously avoided, and the gray expanses carefully explored.

No One Really Knows

Those who want to follow tax law down to the letter will find it virtually impossible since many details are unclear. Donald Rumsfeld, a former secretary of defense, included a wry letter with his 2014 tax filings saying just that. Taxpayers are not obligated to take the most restrictive positions and risk overpaying lots of tax. Where there’s strong grounds to claim that the law doesn’t require it, taxpayers often file their returns assuming less tax is owed, and it’s on the IRS to prove that the claimant is wrong. The ambiguous gray is where the most sophisticated tax strategy happens.

Understanding Black and White

This murkiness doesn’t mean all tax compliance can be thrown to the wind. Those who practice blatant tax evasion find no sympathy with IRS enforcement agents, and even criminal prosecution is possible in egregious cases. My article back then laid out how living under the table is a bad idea, even for those willing to ignore their societal and halachic responsibilities. On the other hand, many people, intimidated by tax complexity, don’t use even simple, entirely legal strategies to drastically lower their tax bills. No kudos, medals, or parades are offered for those who needlessly overpay taxes!

Conquer White lands First

Overpayment through lack of knowledge and planning occurs at all income levels. Common but overlooked tax planning includes using tax-sheltered retirement, health, and college savings accounts; gifting appreciated assets to charity; and shifting income to children. Shifting a large bonus or expenditures to the next year’s tax return also often creates simple tax efficiency. Those in klei kodesh who are eligible for parsonage and qualified tuition reduction can regularly add significant dollars to their pockets.

Business Tax Basics

Similarly, business owners need to get familiar with myriad legal tax-avoidance strategies available to them. For example, most entrepreneurs know they can expense many items and use accelerated depreciation, but not all have contemplated things like HSA-eligible health insurance or paying kids for services rendered to the business. And a qualified small business stock exclusion can save them millions in tax upon the sale of their business. Some tax matters can be huge!

Expanding Investor Tax Tools

While many investors are generally familiar with depreciation, 1031 exchanges, and cost segregations, they may get tripped managing the distinctions between long-term and short-term capital gains or ignoring tax efficiency in non-real estate vehicles. Defined benefit, self-directed, and solo pension plans can potentially shelter significant sums, as can 529 plans. Clearly, there’s lots of white tax territory to be conquered.

How Gray to Go?

But what about the gray areas? How much tax risk to take requires judgment, and it ends up being a business and personal decision. Most reasonably gray tax positions don’t even get audited. And many of the cases that get picked up in an audit and get sent to tax court, where it’s IRS versus taxpayer, are decided in the taxpayer’s favor. Accountants therefore have a lot of leeway to take a chance on gray positions and lower their client’s tax bills. But the stakes can be high. No one wants to trigger an audit, and losing a tax case can lead to significant penalties.

A Risk Spectrum

Note that even tax attorneys won’t say anything with 100 percent certainty. That’s because tax matters are murky, and they won’t risk getting sued by clients who lose in tax court. Along the spectrum, it’s ultimately up to the taxpayer to decide how much of a chance they want to take. They, and the tax advisers who are sticking their necks out too, may have a different risk tolerance for how close to the black they are willing to go. The potential size of the “reward” of the tax position is also a big part of the equation. It’s not worth taking a large audit risk for a small sum of potential tax savings.

Get Personal Tax Advice

Please remember that I’m not a tax attorney or an accountant; do not rely on this for tax or legal advice. And please do not call me asking for a tax consultation. Basi rak le’orer—I come to raise points and educate on the topics, but your financial decisions are on you and your licensed professionals if you have them.

Shrewd Patriots

I’ll end with words from a tax case, Gregory v. Helvering, which went all the way to the Supreme Court in 1934. The taxpayer ultimately lost the case, but as part of his position, one of the judges penned these words which have become quite famous in the tax world:

“Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

Don’t evade taxes illegally. But within the boundaries of the law, work vigorously to lower them.

Want to dig deeper?

Try these related articles

A King’s Buckets and Marginal Tax Rates

Income Taxes: File Yourself or Hire a Professional?

Taxable Income Shifting: An Easy Way to Lower Tax Bills

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