Tax Shelter: A Legal Means to Lower Your Tax Bill
If you want to decrease your tax liability and have more cash in your pocket, you can take refuge in a tax shelter.
What is a tax shelter?
It is a valid method that decreases taxable income, thus helping individual and corporate taxpayers minimize the tax they pay to the federal government. Ever heard of the 401k plan sponsored by companies to their employees? That is one example of a tax shelter. Some tax shelters can be in the form of activities that reduce taxable income (e.g. charitable donations, CSR or corporate social responsibility, etc.) and investments or deposits in accounts (e.g. individual retirement accounts) that offer an attractive tax treatment.
Other legitimate types of tax shelter available to taxpayers include the following:
- Real estate investment – Real estate investors enjoy tax incentives from the Internal Revenue Service (IRS) when they buy properties, thus giving them substantial tax savings. The available deductions for most real estate investments include property taxes, maintenance expenses, mortgage loan interest, and insurance premiums.
- Municipal bonds – The interest earned from municipal bonds, which are used to finance public works projects, are not taxable.
- Setting up your own side business – When you allot a certain amount from your primary income to start and fund your side business, you shelter yourself from federal income tax. You can decrease your taxable income by deducting your business expenses such as supply and equipment costs from your income tax.
- Retirement plans – These legal tax shelters include individual retirement accounts and pension plans such as 401(k) and 403(b).
- Company-sponsored life insurance, health insurance, and education benefits – These and other benefits sponsored by your employer are not taxable. So take advantage of such opportunities to lower your taxable income, which is done by spending part of your income for the benefit before your tax withholding is computed.
In essence, when you use a legitimate tax shelter, you are avoiding payment of a certain amount as tax. Tax avoidance or tax mitigation, however, should not be confused with tax evasion, which refers to the unlawful practice of not paying taxes. The key difference between these two practices is the financial benefit of the shelter. Legal tax shelters typically involve income generation while illegal ones do not. The presence of abusive tax shelters explains why the IRS monitors closely the use of tax shelters. Make sure that you pay your taxes properly by making sure that all your tax shelters are legitimate.
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