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 Pennsylvania, 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 a different matter. They typically involve complex transactions designed primarily to reduce taxes in ways not intended by law. These schemes often have little economic substance other than the tax benefits they purport to provide. The Internal Revenue Service (IRS) and the Pennsylvania Department of Revenue do not recognize abusive tax shelters and actively seek to identify and penalize those involved in such schemes. Taxpayers who participate in abusive tax shelters in Pennsylvania may face substantial penalties, interest on unpaid taxes, and the possibility of criminal prosecution. It is important for taxpayers to ensure that any tax shelter they consider is legitimate and complies with both federal and state tax laws.