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Tax shelter

A financial method or investment scheme that is created primarily to reduce or delay one's amount of taxable income.  Some tax shelters have been outlawed by statute or voided by courts, but others remain legal or even encouraged by law.

 

One of the most well-known tax shelters is the 401(k) savings account, which is deliberately created and permitted by federal law.

Employers who create a special financial plan under 26 U.S.C. 401(k) can help their employees save for retirement while reducing their present taxable income.  Employees can choose to make pre-tax contributions to their 401(k) savings accounts, so that the wages contributed will be excluded from their income tax. 

Furthermore, investment earnings accrued in a 401(k) savings account will not be taxed until funds are withdrawn from the account.  Employees thus gain a financial advantage, because the untaxed compound interest can grow at a quicker rate than it would under continuous taxation.

 "[T]he IRS determined that a Textron subsidiary--Textron Financial . . . had engaged in nine listed transactions.  In each of the nine instances, Textron Financial had purchased equipment from a foreign utility or transit operator and leased it back to the seller on the same day.  Although such transactions can be legitimate, the IRS determined that they were sale-in, lease-out ("SILO") transactions, which are listed as a potential tax shelter subject to abuse by taxpayers.

"SILOs allow tax-exempt or tax-indifferent organizations--for example, a tax-exempt charity or a city-owned transit authority--to transfer depreciation and interest deductions, from which they cannot benefit, to other taxpayers who use them to shelter income from tax.  Where the only motive of a sale and lease back is tax avoidance, it can be disregarded by the IRS and taxes assessed on the wrongly sheltered income."

United States v. Textron Inc. & Subsidiaries, No. 07-2631, slip op. at 5-6 (1st Cir. Aug. 13, 2009) (en banc).