The term “tax Lien”, which has received a lot of attention in the news in recent years, has negative connotations when it comes to fraudulent and illegal schemes to evade income tax. However, this is not always the case. Tax Liens are also any legal strategy used to reduce income tax.
Protect your income with deductions
Claiming a deduction is a perfectly legal way to reduce the amount of income tax you pay to the IRS. You can easily achieve this tax Lien if you choose to spend your income on expenses that can lead to deductions. For example, it is perfectly legal and reasonable to pay for college tuition with a non-credit card student loan for no reason other than taking advantage of the student loan interest deduction. If you prefer to make large charitable donations during the year for the sole purpose of reducing income tax, a deduction is usually allowed as long as all requirements are met.
Tax Liens using investments
In addition to claiming a deduction, you can also protect your income from taxes by choosing the investment that offers the greatest tax savings. The IRS encourages saving for retirement by allowing taxpayers to deduct a certain amount of contributions into a traditional IRA account. Additionally, you achieve tax deferral on all investment income and gains in your IRA because the IRS does not charge income tax on that income until you retire and start withdrawing it.
Illegal tax Lien
The IRS recommends considering the principle of “substance over form” when evaluating investments. What this means is that if a tax strategy is illegal, it won’t be legal by any other name. For example, federal law prohibits transferring the income you earn to other taxpayers with lower tax rates. As an independent contractor, you are responsible for paying all income tax on any income you earn $200,000 in a year. Forming a corporation to earn income and adding a family to your paycheck will not turn your strategy into a legitimate tax Lien. If you are solely responsible for your income, even if you are a corporation, you must receive your salary alone. As a matter of fact, adding family members to your paycheck makes no sense. However, the reason many taxpayers make this type of transaction is that it is easier to hide from the IRS.
Punishment for illegal tax Liens
The penalties for entering an illegal tax Lien are clear but harsh. The IRS treats illicit tax Liens as fraudulent and can impose fines of up to 75% of the tax underpaid as a result of illicit tax schemes. Taxpayers also risk criminal prosecution and imprisonment.
Abusive tax cover-up
However, a tax Lien may also be narrowly defined as a transaction or strategy that generates a tax benefit not intended by Congress or the IRS. Often Tax Lien resort to literal interpretation of statutes to achieve “too good to be true” results. Professor Michael Graetz once defined a tax Lien as “a deal done by very smart people who are very stupid without tax considerations”. The IRS distinguishes between tax avoidance (including legal forms of reducing tax liability, such as retirement plans) and “abuse” tax avoidance (including tax evasion, which is illegal). An example of abusive tax avoidance schemes is the use of trusts to reduce tax liability by overstating deductions or even concealing taxes on income and assets.
Tax Shelter avoidance is often beneficial if considered from an individual or corporate perspective. Tax avoidance may also be desirable from a society-wide perspective. This is because the erosion of the tax base may be an acceptable loss for primarily beneficial tax avoidance, such as charitable donations. Of course, some tax Liens have little or no social benefit and are even harmful.
A “tax Lien” is a special tax avoidance method. A tax Lien is a place – be it a state, country or territory – that typically has a lower corporate or personal income tax rate. Tax Liens may also have other properties that make it desirable to store assets or income there, such as bank secrecy laws, or ease of registration (for forming shell companies), or a lack of transparency in business operations.