What Is a Safe Harbor?

A safe harbor is a legal provision to reduce or eliminate legal or regulatory liability in certain situations as long as certain conditions are met. The term also refers to a "shark repellent" tactic used by companies who want to avert a hostile takeover and purposefully acquire a heavily regulated company to make themselves look less attractive to the entity considering taking them over.

Safe harbor can also refer to an accounting method that avoids legal or tax regulations, or one that allows for a simpler method of determining a tax consequence than the methods described by the precise language of the tax code.

[Important: Safe harbor accounting methods to reduce taxes is not intended to avoid taxes, only to minimize them within the bounds of the law.]

The Basics of Safe Harbors

The phrase "safe harbor" appears in the finance, real estate, and legal industries in a number of different ways.

Safe harbors function as a form of shark repellent used to thwart hostile takeovers. In many cases, a company will make special amendments to its charter or bylaws that become active only when a takeover attempt is announced or presented to shareholders with the goal of making the takeover less attractive or profitable to the acquiring firm. Some examples of shark repellent are poison pills, scorched earth policies, and golden parachutes.

Safe harbor provisions appear in a number of laws or contracts. For example, under rules of the Securities and Exchange Commission (SEC), safe harbor provisions protect management from liability for making financial projections and forecasts in good faith. Similarly, individuals with websites can use a safe harbor provision to protect themselves from copyright infringement cases based on comments left on their websites.

Key Takeaways

  • A safe harbor is a legal provision to reduce or eliminate legal or regulatory liability in certain situations as long as certain conditions are met.
  • The term also refers to tactics used by companies who want to avert a hostile takeover.
  • Safe harbor can also refer to an accounting method that avoids legal or tax regulations.

Special Considerations

Safe Harbor 401K Plans

Safe harbor 401K plans feature simple, alternative methods for meeting discrimination requirements. Created by the 1996 Small Business Job Protection Act, these retirement accounts were created in response to the fact that many businesses were not setting up 401Ks for their employees because the non-discrimination policies were too difficult to understand. These 401Ks give the employer safe harbor from compliance concerns by providing them with a simplified product.

The Safe Harbor Accounting Method to Simplify Tax Returns

Typically, the Internal Revenue Service (IRS) requires taxpayers to treat remodels as capitalized improvements, the value of which generally must be claimed slowly over a long period of time.

However, restaurants and retailers often remodel their facilities on a regular basis to help their businesses look fresh and engaging. As a result, the IRS allowed some restaurateurs and retailers the ability to claim these expenses as repair costs, which could all be deducted as business expenses in the year they were incurred.

Because of this, tax filers had to review a long list of requirements to determine into which category their expenses fall, and the process was confusing. To eliminate confusion, the IRS created a safe harbor accounting method for eligible retail and restaurant businesses. Essentially, these businesses can now choose if their remodeling costs fall into the repair or capitalized improvement categories. Due to this safe harbor, businesses don't have to worry about accidentally making the wrong selection and later being penalized for it.

Example of Safe Harbor Accounting to Sidestep Taxes

To illustrate a safe harbor accounting method that helps a tax filer sidestep a tax regulation, assume a firm is losing money and cannot thus claim an investment credit. It transfers the credit to a company that is profitable and can claim the credit. The profitable company leases the asset back to the unprofitable company and passes on the tax savings.