What is an 'Abusive Tax Shelter'

Abusive Tax Shelter is an investment scheme that claims to reduce income tax without changing the value of the user's income or assets. Abusive tax shelters serve no economic purpose other than lowering the federal or state tax owed when filing. Often, these schemes channel funds through trusts or partnerships to avoid taxation.

BREAKING DOWN 'Abusive Tax Shelter'

People who invest in abusive tax shelters can be penalized by the Internal Revenue Service (IRS). Typically, when the IRS determines someone has used such a scheme, the person will owe back taxes with accrued interest. 

To help taxpayers recognize potential schemes, the IRS has compiled a list of transactions that are abusive tax shelters. If a tax shelter resembles a listed transaction, it is considered abusive and the users may face penalties. One of the more common schemes in recent years has been a micro-captive insurance tax shelter where an entity forms its own insurance company to protect against certain risks. This structure allows the entity to claim a deduction for premiums paid and in turn allows the captive insurance company to exclude portions of premiums from income.

The U.S. Treasury maintains comprehensive regulations for the registration and reporting of certain tax shelters and transactions. Parties who organize or sell interests in these tax shelters must also be registered and maintain lists of investors in the shelters. In addition, investors are required to disclose participation in such vehicles on their tax returns.

The IRS lists five types of transactions that must be reported: listed transactions, confidential, contractual protection, loss transactions and transactions of interest. Businesses of individuals that have engaged in any of these transactions may be required to file Form 8886.    

Materials advisors, individuals who provide aid, assistance, or advice in organizing, promoting, selling, implementing, insuring, or carrying out any reportable transaction, and that earn gross income in excess of threshold amounts set by the IRS, may be required to Form 8918, Material Advisor Disclosure Statement. Material advisors are also required to maintain extensive lists of the individuals and entities where they acted as such for a reportable transaction.  

In addition to increased disclosures, the Treasury is using its regulatory authority to shut down abusive tax shelters by proposing targeted legislation to eliminate specific tax shelters and give the IRS new tools to combat abusive practices.

Contrasting Legitimate and Abusive Tax Shelters

A tax shelter is any investment designed to reduce or avoid income taxes, yet not all tax shelters are abusive or illegal. The most common legitimate tax shelters are employer-sponsored retirements plans like such as 401(k) plans as well as IRAs, which give investors the opportunity to shield investment contributions and earnings from taxation until they are withdrawn.  

  1. Offshore Portfolio Investment Strategy ...

    Offshore Portfolio Investment Strategy (OPIS) was a fraudulent ...
  2. Computer Abuse

    Computer abuse is the use of a computer to do something improper ...
  3. Tax Reform Act Of 1986

    The Tax Reform Act of 1986 is a law passed by Congress that reduced ...
  4. Bank-Owned Life Insurance - BOLI

    Bank-owned life insurance is a type of life insurance bought ...
  5. Tax Break

    A tax break is a savings on a taxpayer's liability. It is also ...
  6. Tax Relief

    Tax relief is any program or incentive that reduces the amount ...
Related Articles
  1. Managing Wealth

    Get A Step Up With Credit Shelter Trusts

    Don't let unexpected taxes eat away at your inheritance or burden your heirs.
  2. Taxes

    Safe Tax Planning For High-Net-Worth Filers

    Planning is essential for the affluent seeking tax breaks. Get to know the legal strategies for saving more.
  3. Retirement

    Estate Planning for Beginners, Part Four

    This is how disclaimer trusts work and when it makes sense to use them in an estate plan.
  4. Retirement

    Estate Planning for Beginners, Part Six

    Credit shelter trusts can be an income tax planning tool for the survivors named as beneficiaries.
  5. Managing Wealth

    Assets the Ultra-Rich Use to Reduce (or Avoid) Taxes

    Paintings, oil wells and yachts can get great tax write-offs for their wealthy owners. All it takes is some smart gaming of the tax code.
  6. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  7. Managing Wealth

    8 Ways To Donate Locally

    Donating locally is a great way to both support and get involved with your own community.
  8. Taxes

    How Tax Cuts Stimulate the Economy

    Learn the logic behind the belief that reducing government income benefits everyone.
  9. Insights

    Why Donald Trump May Never Pay Federal Income Tax Again

    The alleged billionaire, last known to have paid up in 1977, may not have to until 2042 - if then.
  10. Taxes

    Earn Tax-Free Income

    Tax rates are going up, so it pays to find sources of income that the tax collector can't touch. Here are 20 of them.
Trading Center