Tax Shield

What Is a Tax Shield?

A tax shield is a reduction in taxable income for an individual or corporation accomplished through claiming suitable deductions, for example, mortgage interest, medical expenses, charitable donations, amortization, and depreciation. These deductions reduce a taxpayer's taxable income for a given year or concede income taxes into future years. Tax shields bring down the overall amount of taxes owed by an individual taxpayer or a business.

Breaking Down Tax Shield

The term "tax shield" references a specific deduction's ability to shield segments of the taxpayer's income from taxation. Tax shields shift from one country to another, and their benefits rely upon the taxpayer's overall tax rate and cash flows for the given tax year. For instance, since interest payments on certain debts are a tax-deductible expense, assuming qualifying debts can act as tax shields. Tax-efficient speculation strategies are foundations of investing for high net-worth individuals and corporations, whose annual tax bills can be extremely high.

Ascertaining the tax shield can be simplified by utilizing this formula:

** Tax Shield = Value of Tax-Deductible Expense x Tax Rate**

In this way, for example, on the off chance that you have $1,000 in mortgage interest and your tax rate is 24 percent, your tax shield will be $240.

Tax Shields as Incentives

The ability to utilize a home mortgage as a tax shield is a major benefit for some working class individuals whose homes are major parts of their net worth. It likewise gives incentives to those interested in purchasing a home by giving a specific tax benefit to the borrower. Student loan interest likewise works as a tax shield in a similar way. In this way, you could say that assuming debt has a tax benefit since you can involve the interest as a tax-deductible expense.

Tax Shields for Medical Expenses

Taxpayers who have paid more in medical expenses than covered by the standard deduction can decide to itemize to gain a bigger tax shield. For 2019 and 2020, an individual might deduct any amount ascribed to medical or dental expenses that surpasses 7.5 percent of adjusted gross income by filing Schedule A.

Tax Shields for Charitable Giving

Like the tax shield offered in compensation for medical expenses, charitable giving can likewise bring down a taxpayer's obligations. To qualify, the taxpayer must utilize itemized deductions on his tax return. The deductible amount might be all around as high as 60 percent of the taxpayer's adjusted gross income, contingent upon the specific conditions. For donations to qualify, they must be given to an approved organization.

Tax Shields for Depreciation

The depreciation deduction permits taxpayers to recuperate certain losses associated with the depreciation of qualifying property. The deduction can apply to unmistakable property, like vehicles and buildings, as well as to immaterial assets, like computer software and licenses. To qualify, the depreciation must be associated with an asset utilized in a business or income-producing activity, and have an expected life expectancy of over one year. Different conditions might influence the ability for depreciation to be deductible, including, yet not limited to, the duration of ownership of the asset and whether the asset was utilized to build capital improvements.

Figure out what tax shields can mean for an organization's balance sheet; read "What is the formula for computing weighted average cost of capital (WACC)?"