Tax Arbitrage

Written By:
Paul Tracy
Updated August 5, 2020

What is Tax Arbitrage?

Tax arbitrage is the act of profiting from differences in how income or capital gains are taxed.

How Does Tax Arbitrage Work?

Tax shelters are often used to take advantage of tax arbitrage opportunities. For example, a person or business might open an account in a certain country or create a certain legal structure so that the income that flows from these investments is taxed at a more favorable tax rate

The simple fact that the IRS taxes different types of income streams at different rates creates tax arbitrage opportunities every day. For example, investors might choose to put extra cash into stocks rather than bonds because the tax rate on capital gains is lower than the tax rate on earned interest. In the broadest sense of the word, any tax planning can be viewed as tax arbitrage.

Why Does Tax Arbitrage Matter?

Tax rules and guidelines are complex, and few people want to pay more taxes than they have to. Many people and organizations structure transactions and accounts in the most advantageous way possible. 

However, there is a fine line between tax avoidance and tax evasion. Some types of tax arbitrage are illegal, which is why interested parties should always get advice from qualified tax advisors.