A depreciation tax shield is a tax reduction technique under which depreciation expenses are subtracted from taxable income. Tax shields are an important aspect of business valuation and vary from country to country. Their benefits depend upon the taxpayer’s overall tax rate net sales and cash flow for the given tax year. In addition, governments often create tax shields to encourage certain behavior or investment in certain industries or programs.

How Does a Tax Shield Save on Taxes?

The payment of the interest expense is going to ultimately lower the taxable income and the total amount of taxes that are actually due. The main change is the reduction in income tax rates, beginning with 2018 taxes. The corporate tax rate has been reduced to a flat 21%, starting in 2018, and personal tax rates have also been reduced. Tax shields involve investments and purchases that are tax deductible. Some common examples include charitable giving, mortgages, and depreciation expenses. Let’s say a Bookkeeping for Veterinarians business decides to take on a mortgage loan on a building instead of leasing the space because mortgage interest is tax deductible, thus serving as a tax shield.

• Lower-income taxpayers can benefit significantly from this if they incur larger medical expenditures.
• As you review tax shields, compare the value of tax shields from one year to the next.
• Taxpayers who wish to benefit from tax shields must itemize their expenses, and itemizing is not always in the best interest of the taxpayer.
• Tax evaders tend to conceal their income and/or underreport their income on their tax returns.

Depreciation

It can also depend on the type of taxable expenses being used as a tax shield. Tax shields allow for taxpayers to make deductions to their taxable income, which reduces their taxable income. The lower the taxable income, the lower the amount of taxes owed to the government, hence, tax savings for the taxpayer. The best way to maximize the tax-saving benefits of tax shields is to take the tax shield factors into consideration in all business financial decisions. Taking tax shields is a legitimate strategy called “tax avoidance.” The opposite is “tax evasion”—deliberately taking illegal deductions, hiding or not reporting income. Failing to pay what you owe can bring on penalties and possible criminal prosecution.

Example 3 – For Individuals

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Based on the information, do the calculation of the tax shield enjoyed by the company. However, there is no tax shield impact on a business that is incurring losses, since there are no profits to be protected by the shield. Here, we explain the concept along with its formula, how to calculate it, examples, and benefits.

• Tax shields allow taxpayers to reduce the amount of taxes owed by lowering their taxable income.
• A tax shield  is a way for individual taxpayers and corporations to reduce their taxable income.
• When considering using a tax shield, make sure you have enough cash to cover what you plan on spending.
• Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.
• In addition, governments often create tax shields to encourage certain behavior or investment in certain industries or programs.
• The Interest Tax Shield refers to the tax savings resulting from the tax-deductibility of the interest expense on debt borrowings.
• The formula to calculate the interest tax shield multiplies the interest expense by the tax rate.

As per the recent income statement of XYZ Ltd for the financial year ended on March 31, 2018, the tax shield accounting following information is available. But, first, do the calculation of Tax Shield enjoyed by the company. A company is reviewing an investment proposal in a project involving a capital outlay of $90,00,000 in a plant and machinery. The project would have a life of 5 years at the end of which the plant and machinery could fetch a value of $30,00,000.