Tax shield is a way to reduce tax liability by deducting certain expenses from taxable income. It refers to the reduction in taxable income that results from deductions, or other tax-related expenses.
The value of tax shield depends on the tax rate and the amount of the expense or cost being deducted. The higher the tax rate and the greater the amount being deducted, the larger tax shield.
The tax shield formula depends on the type of tax shield being calculated. In formulas, "Tax rate" refers to the applicable tax rate. Below are examples of tax shield formulas.
There are various types of tax shields, including depreciation tax shield, interest tax shield, operating loss tax shield, net operating loss tax shield, and tax credits.
Tax shields can be used by both companies and individuals. In general, any taxpayer who incurs expenses or costs that are tax-deductible can benefit from tax shields.
One of the examples of tax shield is the deduction for interest expense on debt. Because interest payments are considered a business expense, they are deductible from taxable income.
Benefits of tax shield include, Reducing taxable income, Improving financial performance, Encouraging investment, Promoting economic growth and Providing financial flexibility.