Building Your Business Business Taxes How Tax Shields Can Be Used to Reduce Income Tax By Jean Murray Jean Murray Facebook Twitter Jean Murray, MBA, Ph.D., is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008. She has taught accounting, business law, and business finance at business and professional schools for over 35 years, has authored several books on saving money and simplifying your business, and was the owner of startup-focused company Emence Enterprises, LLC. learn about our editorial policies Updated on September 19, 2022 Fact checked by J.R. Duren Fact checked by J.R. Duren J.R. is a terms editor at The Balance, a role in which he focuses on providing clear answers to common questions about personal finance and small business. J.R. has more than 10 years of experience reporting, writing, and editing. As an editor for The Balance, he has fact-checked, edited, and assigned hundreds of articles. learn about our editorial policies Share Tweet Pin Email In This Article View All In This Article What Is a Tax Shield? Examples of Tax Shields How a Tax Shield Saves on Taxes Calculating the Value of a Tax Shield The New Tax Law and Tax Shields How to Take Advantage of Tax Shields Frequently Asked Questions (FAQs) Photo: Korrawin Khanta/EyeEm / Getty Images Businesses looking to cut expenses may consider a tax shield as a way to lower their taxable income. Choosing the right tax shield takes some planning, and may require you to talk with a tax professional. Learn more about what tax shields are and how they work. Key Takeaways A tax shield is a legal way to reduce your tax liability. Any illegal methods of saving on taxes are considered tax evasion.Charitable donations, loans, and depreciation are three common tax shields businesses can use. When making a decision about a mortgage or a loan for new equipment or vehicles, take into account any tax-shield benefits. What Is a Tax Shield? A tax shield is a reduction in taxable income by taking allowable deductions. Stated another way, it's when a business or individual deliberately uses taxable expenses to offset taxable income. Note 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. Examples of Tax Shields Tax shields involve investments and purchases that are tax deductible. Some common examples include charitable giving, mortgages, and depreciation expenses. Charitable Giving Charitable giving is a deductible expense for both individuals and businesses, with some restrictions and limits. For an individual to take a tax deduction on charitable giving, they must itemize deductions. Corporations can include charitable donations with some limits and restrictions. Mortgages A mortgage is a classic tax shield for both individuals and businesses. Note that it's not the amount of the mortgage payment that's deductible; it's the interest expense. Depreciation Businesses can take a depreciation expense for buying business property, including equipment, furniture and fixtures, and vehicles (but not land). Depreciation is basically a way to spread out the expense of buying a business asset over the life of that asset. Accelerated depreciation allows you to depreciate more of the asset in the first year or two, and it's a great example of a tax shield. The two types of accelerated depreciation are Section 179 expenses and bonus depreciation. How Does a Tax Shield Save on Taxes? Tax shields are part of an overall financial strategy. Look at it this way: As a person or a business, you can get tax deductions for certain types of purchases and activities. You can do this by accident, buying whatever you want whenever you want. Or you can save on taxes deliberately by planning purchases to take advantage of tax shields. For example, a business is deciding whether to lease a building or buy the building. Taking on a mortgage for the purchase of a building would create a tax shield because mortgage interest is deductible to a business. If the business puts the tax shield benefit from the mortgage into the decision, the tax benefit of a mortgage might make the decision easier. What Are the Benefits of Tax Shields? Tax shields are part of the overall financial strategy of businesses. Tax shields do the following: Increase expenses, though they lower taxable income.Decrease cash on hand, but they put money into investments that provide a higher return. Note A tax shield also increases the value of a business, which is important if you want to sell your business or get loans and investors. Calculating the Value of a Tax Shield The value of tax shields depends on the following: Your business's effective tax rateThe amount of the deduction For example, if you expect interest on a mortgage to be $1,200 for the year, and your tax rate is 20%, the amount of the tax shield would be $240. Note The easiest calculation is to take the amount of the deduction for the year and multiply it by the tax rate of the person or business. As you review tax shields, compare the value of tax shields from one year to the next. If your business has a higher income and a higher tax rate in one year, the amount of tax savings will be higher in that year. How Does the Tax Cuts and Jobs Act Affect Tax Shields? The Tax Cuts and Jobs Act has several effects on tax shields. 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. Another big change is that the standard deduction on personal tax returns has been doubled, decreasing the value of some tax shields, like mortgage interest and charitable giving. Taxpayers won't be able to take advantage of these tax shields until they reach a level of deductions over the standard amount. How to Take Advantage of Tax Shields 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. Of course, tax savings shouldn't be the only consideration when you are planning your tax strategy for the year, but leaving tax shields out of the planning process can lower the value of your business and leave money on the table, so to speak. Note Don't wait until the end of the year to do your tax planning; some deductions (like depreciation) are pro-rated through the year, so you won't get the maximum savings if you purchase late in the year. Frequently Asked Questions (FAQs) What is a tax shield? A tax shield is a legal way to reduce your tax liability through various means, including charitable donations, a mortgage, and depreciation. What is a tax shield example? A business may consider taking on a loan so that it can deduct the interest it pays on the loan. When considering using a tax shield, make sure you have enough cash to cover what you plan on spending. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Cornell Law School Legal Information Institute. "Tax Evasion." AccountingTools. "Tax Shield." IRS. "IRS Issues Guidance on Section 179 Expenses and Section 168(g) Depreciation Under Tax Cuts and Jobs Act."