Tax shelter

A tax shelter is a method of giving investors certain tax benefits by allowing them to avoid, reduce, or defer payment of taxes. Tax shelters may be legitimate or abusive. The INTERNAL REVENUE SERVICE (IRS) prohibits the use of abusive tax shelters. The federal government loses tax revenues by allowing taxpayers to avoid, reduce, or defer payment of taxes through the use of tax shelters. However, Congress has determined that the loss of tax revenues is acceptable as a side effect of encouraging investors to participate in transactions that promote society’s economic and social wellbeing. Thus the Internal Revenue Code (IRC) has special tax provisions designed to encourage investors to invest in legitimate tax shelters. Examples of legitimate tax shelters include DEPRECIATION of ASSETS such as land, plants, and equipment used in business operations. Depreciation reduces a firm’s taxable INCOME and therefore reduces the amount of taxes a firm must pay. Other examples of legitimate tax shelters include tax-exempt municipal BONDS and INDIVIDUAL RETIREMENT ACCOUNTs (IRAs). Abusive tax shelters, which are strongly motivated by a desire to reduce or avoid taxes, are not legal and produce little or no societal benefit. Often abusive tax shelters offer tax savings far in excess of the actual INVESTMENT placed at risk, but they also often produce little or no income. In order to reduce the use of abusive tax shelters, the IRS has registration and reporting requirements to help identify violations. Organizers of certain tax shelters must register their shelters with the IRS, which then issues them tax registration numbers. Sellers of the tax shelters must provide buyers with the registration numbers of the tax shelters being purchased, and buyers are required to report the tax shelters’ registration numbers in their tax returns. Organizers and sellers of tax shelters must also maintain a list of individuals or organizations that invest in the shelters; this list must be made available to the IRS for inspection. The registration of tax shelters may assist the IRS in identifying investments that qualify as abusive tax shelters and thus penalize users and providers of those shelters.