Definition
A tax shield is reducing taxable income through deductions that are permitted on certain expenses such as depreciation, interest payments, etc. It is calculated as deductible expense times the applicable tax rate.
Example
Tax shield helps companies to increase their cash flows and thereby the business value. Tax Shield calculation = Deduction x Tax RateExample -Suppose, a company has a debt balance of $8,000,000 @ 10% interest and 35% tax rate. With the use of a tax shield, the company can increase its tax savings to the extent of interest payment times the tax rate. Tax shield = 8,000,000 x 10% x 35% = $280,000. Since the interest component of $800,000 is a deductible expense, the company can reduce its tax liability by $280,000.
Why it matters
A tax shield helps lower a company's tax liability. Therefore, companies often spend considerable time identifying deductions and credits that can be used every year for tax savings. Various items/expenses can be used by corporations to claim tax shield benefits.