What is a Tax Haven?
A tax haven is a country or jurisdiction known for generating little or no tax liability.
How Does a Tax Haven Work?
Tax havens exist because countries are usually not obligated to provide customer information to foreign taxing authorities (though investigations of criminal activity, terrorism, or other behavior may require disclosure). Switzerland is the most famous tax haven, followed by a number of Caribbean countries.
Tax havens must have reputable banks in order to attract business, and they must exist in regions with relatively low tax rates. Customers with accounts in tax havens may be required to pay taxes in that region (even if they are not citizens of that country or region), but if those taxes are considerably lower than what the customer would pay on that income in his or her home country, the savings can be considerable, especially over the long term.
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Why Does a Tax Haven Matter?
People sometimes use tax havens to hide income-generating investments. The idea is that because the tax haven does not report the customer's income to the IRS, the customer can avoid paying taxes on that income.
It is important to note that the idea of a tax haven -- low taxes and high privacy -- is not illegal. What is illegal, however, is failing to report income from accounts in foreign countries if the taxpayer's taxing authority requires the taxpayer to do so.
It is also important to note that one does not have to move money offshore in order to find a tax haven. Technically, a tax haven is any investment that shelters income from taxes. Thus, an IRA or 401(k) can be considered a tax haven in this sense because the investor is not taxed on the money going into (or sometimes coming out of) the account.