Types:

Some tax shelters are quasi legal.

* Offshore companies.

By transferring funds to a company in another country, one may claim the transfer as an expense, and so lowering the taxable income. International tax treaties often make the income not legally taxable. e.g. Double tax treaties between Mauritius and China and India let resident Mauritius companies invest into those countries with negligible taxes.

* Financing arrangements.

By paying unreasonably high interest rates to a related party, one can severely reduce the income of an investment (or even create a loss), but create a massive capital gain when one withdraws the investment. The tax benefit derives from the fact that capital gains are taxed at a lower rate than the normal investment income such as interest or dividend.

Other tax shelters can be fully legal.

* Limited Partnerships

Certain companies, such as mining or oil drilling often take several years before they can generate positive income, while many of them will go under. This normally deters common investors who demand quick, or at least safe, returns.

To encourage the investment, the US government allows the exploration costs of the company to be distributed to shareholders as tax deductions (not to be confused with tax credits). Investors are rewarded by:

1) the near instant tax savings

2) the potential massive gains if the company discovers gold or oil. In US terminology, these entities are given the generic title of "limited partnership" and function as tax shelters.

* Retirement plans

In order to reduce burden of the government funded pension systems, governments allow individuals to invest in their own pension and deduct some or all of its income for tax calculations. e.g 401 [k] in the USA. These vary by country and very often are linked to governments trying to influence people behavior during the period the tax saving plan is introduced.

* Owning your own business

The surest way to reduce your taxes is to convert personal expenditures into allowable deductions. Turn even a hobby into a business and you'll cut your tax bill.

You can incorporate yourself, as an Type S or a limited partnership or a sole proprietorship, or even show that there was a profit motive that drove the expenditure. Most governments tax corporate income at lower rates than individual earnings. And your expenses are deductible even if you do not make a profit!

Even if you're employed full time elsewhere, that doesn't prevent you from having another activity on the side, subject to no objections from your current employer, of course. But the expenses you want to deduct must be reasonable since they will be scrutinized thoroughly by the tax man.

* Real estate is a widely used tax shelter

Real estate provides leverage, an inflation hedge, cash flow and equity buildup. As your property appreciates in value, you are allowed a paper deduction for depreciation. If structured correctly, you buy the property with your down payment.

Hopefully, your rents cover your mortgage interest, taxes and operating expenses.

Incorporation of offshore to save your investments and even do business is always an attractive option.