Investments that yield tax benefits are sometimes called tax shelters and can be legal under federal and state laws. But abusive tax shelters are schemes involving transactions with little or no substance that are not recognized by federal and state taxing authorities and that may create taxpayer liability for interest, penalties, and possible criminal prosecution.
In California, as in other states, there are legitimate tax shelters that offer tax benefits to investors, such as retirement accounts (IRAs, 401(k)s), municipal bonds, and certain real estate investments. These are legal and recognized by both federal and state tax authorities. However, abusive tax shelters are illegal. They typically involve complex transactions designed to produce tax benefits that are not intended by the law. These schemes lack economic substance and are not recognized by tax authorities. Engaging in abusive tax shelters can lead to severe consequences, including the imposition of interest, penalties, and the possibility of criminal prosecution. The Internal Revenue Service (IRS) and the California Franchise Tax Board (FTB) actively pursue and penalize abusive tax shelter activities. Taxpayers are advised to be cautious of investments that seem primarily designed to avoid taxes and to consult with a qualified attorney or tax advisor before participating in any tax shelter.
