Legal Tax Shelters

What is a tax shelter? Any way to reduce the tax you pay, typically through reducing your taxable income. There are more techical definitions, but what is important to those investigating tax shelters is this: What are some options for legally reducing the amount of tax I pay?

Here are some legal tax shelters:

1) Tax loss carryforwards through a corporation, or even easier, an LLC which has elected to be taxed as a corporation.
2) Internal Revenue Code Section 1031 exchanges for property/real estate.
3) Certain transactions involving mining or oil drilling companies.
4) Retirement plans like 401(k)s, IRAs, etc.
5) Homeownership: mortgage interest and property taxes are deductible. You might even be able to write off PMI insurance premiums. And when you sell, a homeowner can keep $250K of the profit tax-free ($500K for married couples who jointly own the home).
6) Children. Kids counted as an exemption of $3,400 per child in 2007, and came with a child tax credit of $1,000 per child. Then there’s the Child and Dependent Care Credit and Hope and Lifetime Learning credits…small but they add up.

Unfortunately, as you can see, the list is short. Attorneys and accountants create new tax shelters, but soon after they become widely available, they run the risk of being targeted by the IRS.

Questionable tax shelters to be leery of:

1) Offshore companies/offshore bank accounts/offshore credit cards.
2) Certain financing arrangements where one party pays an unusually high rate of interest to an affiliated party, which initially reduces income, then ultimately reduces the tax bracket that any capital gain is taxed on.

It’s important not to give away what you don’t have to, but you don’t want to face criminal charges either. It’s always best to consult with widely respected professionals, and not be tempted to get “creative.”