Just because you earn a certain amount of money doesn't mean you have to pay taxes on all of it. A tax shelter can help you reduce your taxable income, and keep more of your money. You must, however, make sure you're not breaking the law. Take this quiz to test your knowledge of both legal and illegal tax shelters.
A tax shelter is an investment that allows you to lower your taxable income. You might earn $100,000 a year, but with the right shelter you could see to it that you pay taxes on only a certain percentage of that salary.
Tax evasion -- refusing to pay the taxes you legally owe -- is a federal crime punishable by a fine and imprisonment. The abuse of a tax shelter is considered tax evasion.
The Internal Revenue Service (IRS) keeps a close eye on the use of tax shelters, and investigates any suspected abuse.
The IRS estimates that in 2003 the State of California was shorted as much as $1.3 billion through the illegal use of tax shelters.
In 2005 the international accounting firm KPMG was involved in a complex tax evasion scam that cost the U.S. government more than $2.5 billion.
One of the reason many tax shelters are legal is that they generate income that will eventually be taxed.
When you purchase real estate you have the right to deduct some of the mortgage insurance you pay.
A 403(b) is a retirement account available to employees of tax-exempt organizations, such as clergy, and to public schools employees.
If there were no caps on the amount you could contribute to an IRA, then people would simply dump all their extra money into one, which would drastically reduce their taxable income.
A small business can be an excellent tax shelter. By diverting funds from your income to run the business, you can reduce your taxable income.
By opening a business that has no purpose but to contribute to a Roth IRA, people can hide money from the IRS.
The Inflated Partnership Basis Transactions (also known as Son of Boss) scheme that was popular in the 1990s involved inaccurate reporting of business losses. Once caught, the average participant paid the IRS $1 million, but one participant paid over $100 million.
In total the IRS was able to collect more than $3 billion dollars from the participants in the Son of Boss scheme.
Sometimes an American company will form a corporation in a foreign country with more favorable tax laws, such as Panama and Belize, to avoid paying American taxes. This is known as an offshore tax haven.
The interest earned from municipal bonds, which are investments that help funds local government projects and organizations, is not taxable.