A tax shelter enables you to reduce your taxable income and liabilities legally. There are numerous ways to take advantage of tax shelters for deductions and credits. Tax shelters include 401(k) plans, municipal bonds, investments, and other options for taxpayers to reduce liabilities and minimize their tax exposures. These tax shelters can either reduce taxes owed, or they may defer taxes depending on the route taken. Tax evasion, however, is very close to utilizing one of these shelters, so you need to consult your accountant about your financial plan.

Tax Strategies

Tax shelters will utilize one of two strategies to assist taxpayers. The first strategy seen is to minimize tax liability. This is accomplished by reducing taxable income by claiming various deductions and credits available to taxpayers. A tax deferral is the second strategy used by those who employ tax shelters. This method’s goal is to defer, postpone, tax payments. This is most commonly seen with traditional IRAs when contributions are tax-free, but withdrawals performed at a later date are taxed.

The third strategy used by taxpayers is different than a tax shelter and is called a tax haven. Although they are similar, they have different guidelines that distinguish them. Tax havens are accomplished through the use of offshore accounts and are often thought to be underhanded. By doing this, people can move their assets out of the country to avoid paying taxes in the countries where they are located and instead pay taxes in countries where rates are lower.

The fourth strategy is tax evasion. This strategy is the illegal practice of attempting to avoid paying taxes by using illegal means. This includes concealing income, under-reporting income, or claiming false deductions. Tax evasion is a serious crime and can lead to hefty fines, jail time, and other sanctions.

Types of Tax Shelters

Various tax shelters are available to help reduce taxes. These tax shelters include deductions, credits, exclusions, and exemptions. Deductions will assist in reducing taxable income and credits, and exemptions will help to reduce the taxes that are owed. Each type of tax shelter has its own rules and requirements, so it is important to consult with a tax professional to determine which one is right for you.

• Charitable Contributions

  Donations to certain, qualified organizations can reduce your tax liability. For many taxpayers, up to 50% of their adjusted gross income can be deducted when making contributions. However, there are limitations when donating. Consulting with your accountant can help obtain a better understanding of qualified donation limitations.

• Conservation Easements

  This is a permanent, legal, and voluntary agreement to protect property. The landowner still retains private property rights but must abide by the agreement to protect the land. Creating this conservation also creates tax benefits to the landowners allowing them to claim a tax deduction based on the value of the easement.

• Municipal Bonds

  These are utilized by the city, county, or state to raise money for projects. They’re beneficial to taxpayers because of how they are structured. Since the bond is essentially a loan to the government, interest (also referred to as a coupon rate) is accumulated, but, as a thank you, the interest is tax-free federally and, in the majority of situations, free from state and local taxes as well.

• Mutual Funds

  Many people invest in mutual funds as a way to diversify their financial portfolios, and when they are utilized to invest in government or municipal bonds, the interest grown from these funds is tax-free. Yet, mutual funds often accumulate other fees that may negatively impact the overall benefit, so it’s advantageous to consult your accountant.

• Retirement Accounts

  Depending on the retirement account that is involved will depend on the type and amount of savings. The major difference seen with the different types of retirement accounts is when the taxes are paid. For example, with a Roth IRA or 401(k), the taxes are paid upon deposit, but withdrawals are tax-free. With a Traditional IRA or 401(k), the funds are deposited tax-free but are taxed when withdrawn. Therefore, when choosing a retirement path, it is important to consider if you are in a higher tax bracket now or will be in the future.

• Foreign Investments

  These investments enable taxpayers to utilize the foreign tax credit to reduce their income tax liability. This applies to those who pay taxes to a foreign government on income earned from foreign investments. Similar to the foreign-earned income credit discussed in one of our other articles, this credit assists in preventing double taxation.

• Oil and Energy Investments

  Shareholders who invest in the oil and gas industry can reduce their taxable income by the exploration and development costs incurred as if they were a direct expense to the shareholder. The IRS enabled this tax saving to increase interest in investing in this field.

• Real Estate Investment Trusts

  Those who invest in real estate can reduce their taxes in multiple ways. For instance, IRS Section 1031 enables those who sell a property to use the earnings from the sale to purchase a similar asset without being concerned about capital gains. Rental losses are also occasionally able to be deducted from rental income to assist in offsetting any losses, and investors can receive depreciation deductions as well.

• Medical and Dental Expenses

  You may be able to claim certain medical and dental expenses as tax deductions depending on how they are paid for. Flexible spending account contributions are deducted from paychecks before taxes are applied and health savings account contributions are tax deductible. Additionally, any medical expenses that have not been reimbursed above 7.5% of their adjusted gross income are able to be deducted.

There are various other tax shelters that are available such as 529 plans and certain business deductions. Tax shelters can be advantageous to taxpayers by reducing their tax liability. It is important to be aware of all the options available and to take advantage of them whenever possible. Tax professionals can be consulted to help taxpayers identify the best tax shelters for their situation. Tax shelters should be considered when filing taxes to ensure the lowest possible tax liability.

Legalities

Attempting to reduce yearly taxes is a goal that many taxpayers strive for. While tax shelters and other strategies are legal, the IRS is stringent in following the regulations they have provided. If the IRS notices any divergence from their guidelines, severe consequences will be imposed. The government is increasingly cracking down on tax evasion, and a variety of measures have been taken to discourage people from engaging in it. That is why it is more important than ever to consult with your accountant to certify that you are filing your taxes appropriately to eliminate any possible ramifications. Contact Kislay Shah CPA to discuss how to take advantage of the tax shelters available to you. Reach us today at kislay@shahcpaus.com or call 646-328-1326.