Tax shelters are investments or activities that reduce one's taxable income. A tax shelter may take advantage of certain investments that receive favorable tax treatment (401(k) for example), or may be transactions that reduce one's taxable income (depreciation of assets for example).

Abusive tax shelters stretch tax law illegally, through misrepresentation of one's tax liabilities. A classic example of this is where an entity inflates the fair market value of a purchased property in order to claim extra depreciation deductions. That is way tax shelters are closely watched by the IRS.

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