Loading the player...

What is a 'Tax Shield'

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

BREAKING DOWN 'Tax Shield'

The term "tax shield" references a particular deduction's ability to shield portions of the taxpayer’s income from taxation. Tax shields vary from country to country, and their benefits depend on the taxpayer's overall tax rate and cash flows for the given tax year.

For example, because interest payments on certain debts are a tax-deductible expense, taking on qualifying debts can act as tax shields. Tax-efficient investing strategies are cornerstones of investing for high-net-worth individuals and corporations, whose annual tax bills can be very high.

Tax Shields as Incentives

The ability to use a home mortgage as a tax shield is a major benefit for many middle-class people whose homes are major components of their net worth. It also provides incentives to those interested in purchasing a home, by providing a specific tax benefit to the borrower. Student loan interest also functions as a tax shield in the same manner.

Tax Shields for Medical Expenses

Taxpayers who have paid more in medical expenses than covered by the standard deduction can choose to itemize in order to gain a larger tax shield. For the 2016 tax year, an individual may deduct any amount attributed to medical or dental expenses that exceeds 10% of his adjusted gross income, while a person over the age of 65 may deduct amounts over 7.5% of his adjusted gross income.

Tax Shields for Charitable Giving

Similar to the tax shield offered in compensation for medical expenses, charitable giving can also lower a taxpayer’s obligations. In order to qualify, the taxpayer must use itemized deductions on his tax return. The deductible amount may be as high as 50% of the taxpayer’s adjusted gross income, depending on the specific circumstances. For donations to qualify, they must be given to an approved organization.

Tax Shields for Depreciation

The depreciation deduction allows taxpayers to recover certain losses associated with the depreciation of qualifying property. The deduction can apply to tangible property, such as vehicles and buildings, as well as to intangible assets, such as computer software and patents. In order to qualify, the depreciation must be associated with an asset used in a business or income-generating activity, and have an expected lifespan of more than one year. Other conditions may affect the ability for depreciation to be deductible, including, but not limited to, the duration of ownership of the asset and whether the asset was used to build capital improvements.

Find out how tax shields can affect a company's balance sheet; read "What is the formula for calculating weighted average cost of capital (WACC)?"

RELATED TERMS
  1. Tax Deduction

    A deduction from gross income that arises due to various types ...
  2. Schedule A

    Schedule A is a U.S. income tax form that is used by taxpayers ...
  3. Itemized Deduction

    A deduction from a taxpayer's taxable adjusted gross income that ...
  4. Standard Deduction

    A base amount of income that is not subject to tax and that can ...
  5. Tax Deductible Interest

    A borrowing expense that a taxpayer can claim on a federal or ...
  6. Charitable Contributions Deduction

    One of the itemized deductions available for taxpayers who donate ...
Related Articles
  1. Taxes

    What's a Tax Shield?

    A tax shield is a deduction, credit or other means used to reduce the amount of taxes an individual or business owes to the government.
  2. Taxes

    An Overview of Itemized Deductions

    Not taking the standard deduction this year could save you hundreds of dollars.
  3. Taxes

    Calculating the Mortgage Interest Tax Deduction

    The amount of money you save by paying your mortgage off quickly will far exceed any benefit from the mortgage interest tax deduction.
  4. Taxes

    Want A Bigger Tax Refund? Don't Itemize

    Six reasons why many taxpayers can save money and time by claiming the standard deduction.
  5. Taxes

    Tax Credits And Deductions For Parents

    Your children can help you save on your taxes with these credits and deductions.
  6. Retirement

    Top Tax Tips For Retirees

    Filing your taxes during retirement can be just as time consuming as when you were employed. We have some tips to help you out.
  7. Taxes

    Do Your Research Before Claiming These Deductions

    Be sure to read the fine print about any deduction or credit that you’re planning to claim.
  8. Taxes

    Explaining Taxable Income

    Taxable income is the net of gross income and allowable deductions.
  9. Taxes

    What to Do This Year with Tax Cuts Coming in 2017?

    Here are several strategies that taxpayers can use to make the most of the likely coming tax cuts following Donald Trump's win.
  10. Taxes

    What's IRS Form 1040 For?

    Most U.S. taxpayers will be familiar with the 1040. By the end of filling it out, you'll know how much tax you owe, or what your refund is.
RELATED FAQS
  1. How do I know whether to itemize deductions or take the standard deduction?

    Taking the standard deduction is the easiest and most common method chosen by filers, but many taxpayers may wind up paying ... Read Answer >>
  2. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow Read Answer >>
  3. How can I lower my effective tax rate without lowering my income?

    Discover how to reduce your effective tax rate without losing income by maximizing adjustments and deductions, earning tax-free ... Read Answer >>
  4. How is the deductible I paid for my insurance claim treated for tax purposes?

    Find out how your health insurance deductible is treated for tax purposes and under what conditions you may be able to deduct ... Read Answer >>
  5. What are some ways to minimize tax liability?

    Learn what tax strategies are available to individuals and business owners that may allow for a reduction in tax liability ... Read Answer >>
Hot Definitions
  1. Quadruple Witching

    The expiration date of various stock index futures, stock index options, stock options and single stock futures. All stock ...
  2. Co-pay

    A type of insurance policy where the insured pays a specified amount of out-of-pocket expenses for health-care services such ...
  3. Protectionism

    Government actions and policies that restrict or restrain international trade, often done with the intent of protecting local ...
  4. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  5. Demonetization

    Demonetization is the act of stripping a currency unit of its status as legal tender and is necessary whenever there is a ...
  6. Investment

    An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic ...
Trading Center