What is Tax Shield?

A tax shield is referred to a decrease in taxable Income for a business or an individual that is accomplished by claiming allowable deductions, such as interest on the mortgage, medical expenditure, charitable donations, and more.

These deductions help reduce the Taxable Income of a taxpayer for a certain year. It may also help deferring income Taxes for the future years. In simple words, tax shields help to decrease the overall tax amount that a business or an individual has to pay to the government.

Understanding Tax Shield

As mentioned above, this term is referred to specific abilities of a Deduction to shield a part of the income from taxes. However, such shields vary from a nation to nation, and their advantages also depend upon the overall Tax Rate of the taxpayer and the cash flow for a tax year.

For instance, since interest payments on specific debts are tax-Deductible expenses, taking qualified debts can act as a tax shield.

Tax Shield Formula and Example

Also, this Factor can be calculated by using this tax shield formula:

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

Now, let’s take an example here. Suppose you have to pay Rs. 10,000 for mortgage interest and the tax rate is 20%. This way, your tax shield will be: Rs. 10,000 x 20% = Rs. 2,000

Types of Tax Shields

• Shielding Incentives

The Facility to use the home mortgage as a tax shield type is one of the substantial advantages for several middle-class people. It also offers incentives to the ones who are interested in buying a new house. In fact, the student loan interest is also covered in the tax shield.

• Shielding Medical Expenditure

Those taxpayers who have been paying higher medical expenditure in comparison to what is being covered in the standard deduction can itemize to acquire a large tax shield.

• Shielding Charitable Contributions

Quite similar to the shield provided in compensation against medical expenditures, charitable contributions can also help decrease the obligations of a taxpayers. To qualify, you would have to use itemized deductions on your Tax Return. Also, to get qualified for donations, you must have contributed to a government approved organization.