Income tax shelters may seem like an attractive way to minimize your tax liability and keep more money in your pocket. However, income tax shelters can be dangerous if you don't do your research, exposing you to fraud and violation of income tax laws. Make sure you choose the right income tax shelters, and you can legally reduce your taxes and plan for your future.
"Income tax shelter" is a generic term.
The term "income tax shelter" encompasses a broad range of financial devices that help to reduce your tax liability. The phrase "income tax shelter" could refer to everything from your 401(k) retirement plan to real estate or other investment types that reduce your tax liability. While income tax shelters are legal ways to reduce your liability and lower your taxes, beware of tax shelters that promote tax evasion. Tax evasion is illegal and you could face high fines and penalties for it, whereas tax reduction via legal income tax shelters is permissible under income tax laws. Generally speaking, income tax laws permit income tax shelters that have legitimate purposes, such as investing or retirement planning, but prohibit tax shelters whose sole purpose is tax evasion.
Consider the type of income tax shelter that suits you best.
Because income tax shelters span such a broad range of investments, they are not a one-size-fits-all solution. If you're using an income tax shelter to minimize your tax liability, find one that best fits your financial situation and risk tolerance. The most popular tax shelters for low and middle-class income brackets are company-sponsored 401(k) plans. However, if you're in the upper-middle-class or upper-class income bracket, contributing the maximum to a 401(k) plan is barely going to make a dent in your tax liability. At high income levels, you may want to consider real estate or other investment-related income tax shelters to help reduce your liability. If you're not sure what type of income tax shelter to use, consult a CPA or other income tax law professional for assistance.
Beware unscrupulous or illegal income tax shelters.
While legitimate income tax shelters are perfectly legal, the term "tax shelter" is now infamous after the exposure of the KPMG tax shelter fraud. US income tax laws define tax evasion as illegal, and closely examine income tax shelters for any sign that they may be participating in illegal tax evasion. The KMPG tax shelter scandal involves the creation of a fraudulent entity for the sole purpose of minimizing tax liability; the KMPG tax shelter has no legitimate purpose other than minimizing taxes.
Legal income tax shelters include investments, loan payments and retirement plans; all of which have a legitimate purpose in addition to providing income tax shelter. Illegal tax shelters generally don't have a true business purpose, but exist only to reduce taxes owed. In some cases, illegal tax shelters may provide fraudulent documents to members to file with the IRS showing losses or loan interest to offset income and capital gains.
While we all need to pay our taxes, you shouldn't pay more than you actually owe. Understanding a few basic income tax tips can greatly lower your tax liability. You can claim a number of tax deductions in order to lower the actual amount of tax you pay. However, you should be aware of issues such as raises and the alternative minimum tax (AMT), which may alter your income tax analysis.
Nearly 75 percent of Americans receive a tax return each year, with each return averaging nearly $2,500. That's a nice windfall for most of us but that doesn't mean you should run out and spend it like it's burning a hole in your pocket.
Use our checklist as a guide to help you gather necessary forms and receipts for preparing your income tax return.