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What is a tax shelter?

Tax shelter

A tax shelter is any method or vehicle, used by taxpayers with the aim to decrease or minimise taxable income and, therefore, tax liabilities. There are various types of tax shelters: from investments with favourable tax treatment, to activities, helping to lower taxable income. One of the most popular and widely used tax shelter examples is making contributions to retirement accounts.

Where have you heard about tax shelters?

Tax shelters have gained a bad reputation, because of some illegal methods, including offshore companies and bank accounts, which hide individual or corporate profit and income from the government authorities to avoid tax burden. However, there are numerous havens for law-abiding citizens that help to cut their taxes down.

What you need to know about tax shelters.

How do tax shelters work? When an individual or a company use various sources reducing their income, we say that they shelter their taxes. The route, chosen to erase of decrease the tax liability can be both, legal and illegal. However, while selecting an appropriate tax reduction strategy, taxpayers try to avoid being penalised.

There are numerous official tax shelters, offered by the government to help its taxpayers reduce their tax liability. For example, tax deductions, or amounts of earned income that may be exempt from the individual’s taxable income. The tax rate, applied to the lower taxable income, will lead to a lower tax bill. Other tax shelter examples, provided in the form of tax deductions include mortgage interest deduction, student loan interest deduction and charitable contributions.

Other popular legal ways to minimise taxes and save more money include:

  • Contributions to retirement accounts. It is considered one of the best ways to protect your income from tax burden and accumulate capital for future. There are numerous retirement accounts, offered to individuals, including the IRA (individual retirement account) or the 401(k) and 403(b) plans, provided by the employer. They usually come with different rules and annual limits for contributions.

  • Workplace benefits. Working for a company an individual may use benefits, including health and disability insurance. This cost is usually deducted from your paycheck before taxes. An employer may also provide reimbursement for substantial expenses for education or car allowance, which is also regarded as nontaxable income.

  • Start a new business. Whether you’re going to become a full-time entrepreneur or just want some extra income, having a business offers you another way to shelter your money from taxes. If you try to make a profit from your business, you may turn some of your personal expenses into business deductions. For example, a laptop, a smartphone and accounting software can be considered as reasonable and necessary expenses for running your business.

  • Become a homeowner. Real estate also serves as a real powerful tax shelter. Property ownership may also help to reduce your taxes.

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