Depending on your frame of reference, an offshore tax shelter is either a loophole for wealthy individuals to avoid paying taxes, a fixture of the international system that corporations use to minimize their legitimate taxes due, or a species of tax fraud that will instantly raise the eyebrows of the Internal Revenue Service if you try it. Nevertheless, there are any number of people who make quite a bit of money convincing individuals that they can dodge otherwise valid taxation by the use of a corporate shell game in offshore locales. If you are even remotely considering offshore activity, or are about to pay somebody for a CD, DVD, book, or “seminar” about the advantages of offshore activity, you would be well served to talk to a tax lawyer first.
Offshore tax shelters attempt to use the differences between the tax codes in different countries to make income subject to a lower tax rate. Sometimes this is legal, and sometimes it is not. For most individuals, using offshore accounts to hide income is viewed by the Internal Revenue Service as an abusive tax evasion scheme and will trigger an audit (at best) and a lengthy prison term (at worst.) The shelter schemes frequently use multiple corporations or trusts, each spilling money into each other until it eventually slips out to a country which is not interested in taxing the money, and is willing to keep the details of the transactions secret.
The schemes sound to good to be true and they are. Here is the key point to remember about offshore tax shelters: if the scheme only shifts ownership of assets or income on paper, and the assets and income are still really under the control of a United States taxpayer (or provide a benefit to the taxpayer) then no matter how complex the scheme, the money is still income that must be declared and taxed in the United States.
Because simply stockpiling money offshore does not provide a way to enjoy the money, offshore schemes attempt to put assets and income outside the reach of the United States government on paper, and then somehow repatriate the money back into the country. Methods of getting that money back into the United States might include: credit cards, pre-paid debit cards, “loans”, “scholarships” for the taxpayers’ dependents, fraudulent rental agreements, “gifts” or payable through accounts. In any of these cases, the IRS makes offshoring and repatriation of offshore funds one of its highest enforcement priorities, and using most of these schemes to secretly bring money back into the United States does nothing more than to prove that the taxpayer knew the scheme was illegal. After all, if it was a valid shelter, why not declare the income and explain why it is not taxable?
The bottom line is this: citizens and residents of the United States are taxed on their income regardless of where in the world the income (or asset that creates the income) might be located. There is a credit to offset the effect of overseas taxation on income so that taxpayers are not hurt by double taxation as much as they might be. But money being generated for the use of or under the control of a United States taxpayer, or money that inures to the benefit of a United States taxpayer, is taxable. If a taxpayer is considering use of offshore accounts or funds to reduce taxes, they should not take any action without consulting a tax attorney about the possible legal implications.