A tax shelter is any method of reducing your taxable income, thus reducing the amount owed in taxes. Some would call tax shelters loopholes in tax laws, exploited by tax-payers in order to avoid paying taxes. Others, including the IRS, acknowledge these tax shelters as a means of creating investments which ultimately benefit both the tax-payer and the economy.
Though not all tax shelters are legal or ethical, there are many which are legal to use, and ultimately help to reduce the burden of taxes for anyone who chooses to utilize them. Tax shelters were created to be a program in which all citizens could participate in order to reduce their taxes. However, there are those who distort the intentions of these programs who, although being within the boundaries of tax law, act unethically and exploit these programs. For this reason, tax shelters are often associated with fraud, and are not seen as the beneficial program they were intended to be.
Legal Tax Shelters
As previously mentioned, many tax shelters are legal and beneficial to anyone who uses them. These legal tax shelters include investments in companies such as mining and drilling, as well as creating annuity-based accounts to be paid back over time.
Investments in mining and drilling were designed to work as a tax shelter in order to encourage people to make these investments. Companies such as these often take several years to begin to generate positive income, which is unappealing to most investors who expect quick and reliable returns on their investments. In response to this, the government has created a program for the costs of exploratory drilling to be distributed among investors as tax deductions. This creates instant tax savings, as well as the potential for large profits should the company invested in strike gold or oil.
Tax Shelter Annuity
A tax sheltered annuity is a contract that is offered by either an insurance company or an employer that allows an employee to designate a portion of his paycheck to be withheld before calculating taxes. This withheld money is then paid back to the employee in the form of annuity payments generally received after retirement, where the money is then made taxable. Tax sheltered annuity provides a legal and reliable way to reduce the amount owed in taxes, distributing it over a period of several years. Should money be withdrawn from the annuity account before the specified time that payments are to begin, however, significant penalties will apply, as well as the previously tax-deferred monies becoming immediately taxable.