Definition
The finance term abusive tax shelter refers to a transaction that serves no other economic purpose other than lowering the amount of taxes owed. Abusive tax shelters typically take the form of an investment scheme that claims to be able to reduce the level of income taxes paid without changing the value of the taxpayer's assets or income.
Explanation
Also referred to as tax avoidance transactions, abusive tax shelters usually involve transactions, such as an investment, that serves no true economic purpose other than its claim to lower the amount of income taxes owed the federal or state government.
The Internal Revenue Service (IRS) maintains a list of transactions it considers abusive tax shelters. Taxpayers conducting transactions appearing on that list, or ones resembling a listed transaction, may be penalized by the IRS. Penalties typically consist of the taxes owed plus accrued interest. Abusive tax shelters may involve complex levels of both domestic as well as foreign entities to conduct pass-through transactions. Examples of such entities include Limited Liability Corporations (LLC), Partnerships, S-Corporations, as well as trusts.
The IRS frequently investigates promoters of what appear to be tax avoidance transactions. The IRS will oftentimes require promoters to disclose both the types of transactions conducted as well as a list of investors participating in each transaction.
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