What is the key difference between tax avoidance and tax evasion?

The key difference between tax avoidance and tax evasion lies in the methods used and their legality. Tax avoidance is a legitimate practice where individuals or businesses plan their finances in such a way as to minimize tax liability through legal means. This can include taking advantage of tax deductions, credits, and allowances provided by law. It operates within the framework of the law and is considered acceptable.

On the other hand, tax evasion is illegal and involves actively concealing income or falsifying information to reduce tax liability. This can include underreporting income, inflating deductions, or hiding funds in offshore accounts. Tax evasion is a criminal offense and can lead to severe penalties, including fines and imprisonment.

Understanding this distinction is crucial in taxation, as it reflects both legal tax strategies and illegal activities. The other answer choices misrepresent the concepts: for example, tax avoidance is not illegal, it applies to various entities including individuals, and it is not restricted to certain types of income or taxes.