Tax shelter definition
/What is a Tax Shelter?
A tax shelter is an investment that generates either tax-deferred or tax-exempt income. A tax shelter takes advantage of various aspects of the tax code. For example, it may generate tax-deductible losses via the use of depreciation or interest expenses. Or, a tax shelter can take advantage of incentive tax deals, or of the interest exemption on government debt.
Example of a Tax Shelter
An example of a tax shelter is a SEP IRA investment account, in which a person places funds for which taxable income will not be due until the person reaches retirement age (and at which point the person will presumably be in a lower tax bracket). Another example is municipal bonds, for which the interest income is usually tax exempt. Municipal bonds are especially useful investments for people in higher tax brackets, since they can avoid a substantial amount of tax on the interest earned.
Abusive Tax Shelters
A tax shelter is considered to be abusive if it exists primarily to reduce taxes to an inordinate extent. The IRS can impose fines and penalties when it decides that a tax shelter is abusive. A tax shelter is usually not considered to be abusive when it involves a risk of loss that is proportionate to the amount of the investment.