How Do Tax Shelters Work?

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Category: Individual Taxes

Written by Jonah Sparks

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Tax shelter. It sounds like a wonderful thing. Be honest, if you’re going to need shelter from things in this life, storms and taxes are probably near the top of your list. But what is a tax shelter and how does it work?

A tax shelter is a type of investment that allows you to reduce your tax liability. Examples include investments in retirement plans and real estate. You can also reduce your taxable income if you have losses on investments.

You may have heard of offshore tax shelters. How do they work?

A company can incorporate in countries with less stringent regulations than those imposed by the IRS. Many countries allow businesses to keep income secret from the government of the country in which the business is actually headquartered. For example, you could open a small office in Belize although your multi-billion dollar business doesn’t actually perform any work in Belize. The income earned by your business can be protected from taxing agencies.

It’s done fairly easily in Belize. You need only one director and one shareholder. There are no requirements for public filings, you are not required to file an annual return and your accounts will not be audited. These loose standards allow you to be as secretive as you wish.

You will find similar advantages in Cyprus, Malta, Singapore and Mauritius in addition to several countries in the Caribbean. There are several governments interested in helping the rich get richer. The latest estimates indicate that there are approximately sixty-five tax havens spanning the globe.

The promoters of these tax shelters cite several advantages. Probably the most significant is that the countries in which the funds are kept have few, if any reporting regulations, which blankets the investor’s banking services in secrecy. This secrecy protects your wealth from lawsuits, creditors and the almighty IRS. Estate taxes can also be avoided this way.

Individuals and companies alike can use the banking systems of these countries for their savings and they’ll be afforded the same privacy and tax advantages as the entities incorporating in them. Unfortunately, these shelters have been abused by those engaged in illegal activities like drug smuggling and sex slavery.

The amount of money that can be saved through these tax shelters is beyond staggering. It’s been estimated that as much as ten billion dollars in lost tax revenues has been taken from the United States alone.

Be aware that this kind of lost tax revenue has not gone unnoticed by governments and watchdog organizations. Many non-profit organizations have focused the world’s attention on the premise that the loss of revenue has contributed not only to the underdevelopment of poorer countries but also to the economic problems within the countries from which this money is hidden. Specifically they claim that education and health care are not properly funded while money that should have been collected as tax to address these issues is being hidden in illegal tax shelters.

Some promoters of offshore tax shelters say that these tax havens are not only for the rich and powerful. They claim that they also exist for the little guy and the amount of money involved is truly overwhelming. While some continue to debate their legality and their morality, others are protecting their wealth from the tax man.

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