What Is a Safe Harbor? Types, and How They Are Used

What Is a Safe Harbor?

A safe harbor is a legal provision to sidestep or eliminate legal or regulatory liability in certain situations, provided that certain conditions are met.

The phrase safe harbor also has uses in the finance, real estate, and legal industries. The term safe harbor may also be used to refer to a "shark repellent" tactic used by companies who want to avert a hostile takeover; the company may purposefully acquire a heavily-regulated company to make themselves look less attractive to the entity that is considering taking them over.

Safe harbors are also accounting methods that avoid 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.

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.

Understanding Safe Harbors

A safe harbor may refer to a strategy used by companies that are trying to thwart a hostile takeover. 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.

Safe harbor provisions, as they relate to regulatory liability, appear in a number of laws or contracts. For example, under the regulatory guidelines 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.

Types of Safe Harbors

Safe Harbor 401(k) Plans

Safe harbor 401(k) plans feature simple, alternative methods for meeting non-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 401(k) plans for their employees because the non-discrimination policies were too difficult to understand. These 401(k) plans give the employer safe harbor from compliance concerns by providing them with a simplified product.

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 can then all be deducted as business expenses in the year they were incurred.

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

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 a Safe Harbor

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.