The tax shield plays a vital role in taxable income. It is the reduction in taxable income that results from getting an allowable deduction from the taxable income. This taxable income can be mortgage interest, charitable donations, amortization, medical expenses, and depreciation. The mentioned deductions help lower the table income of taxpayers for a year. Tax shields reduce the overall taxes owed by an individual, corporation, or business.
Small and big businesses can benefit from the use of a tax shield. It boosts the value of an organization or corporation as it reduces the tax liability or lowers the number of assets. It improves the cash flow of a business because it reduces the tax, which means a lower cash outflow. A tax shield is necessary because many companies add it into consideration when deciding on the optimal capital structure. The capital structure is the combination of debt and equity funds that a business uses for operations. Therefore, the owed money’s interest is tax-deductible, and it gives a mortgage an inexpensive financing option.
Importance of Tax Shield
Tax shield plays a vital role in the depreciation method that a business must follow. To budget the depreciation expenses and reduce the tax liability in the starting years, a business may try the sum-of-years-digits and double-declining balance approach. Keep in mind that the depreciation method will not affect the total amount of depreciation over an asset. The significance of tax shield is mainly on the time value of money, and it allows the reduction of tax expenses to later years.
Tax shield also helps businesses and individuals to have cash savings. It happens because depreciation is an expense that requires no cash and the tax results to a real cash outflow. It results in higher depreciation that allows cash savings to corporations and businesses. Moreover, tax shield influence most companies and corporations in creating crucial decisions. For instance, a business is deciding whether to buy or rent a building. The best thing that the business can do is check and evaluate the tax benefits it can get by getting a mortgage to buy the building.
Tax shields can be applicable when there are an effective tax rate and the right amount of deduction. Once you have these two essential factors, you can apply a tax shield for yourself or your business. A tax shield is applicable if you have a continuous income flow and if you have owned properties, corporations, and businesses. Any individual who does not have monthly income cannot apply any tax shield because there is no income source, and it can be complicated for the tax shield agent or tax shield company.
Who can benefit from the tax shield?
As mentioned earlier, the tax shield offers lots of benefits to businesses, individuals, and corporations. So here is a brief explanation of who can benefit from the tax shield.
Companies and Businesses
Tax shield mainly benefits companies and businesses, particularly in performing crucial financial decisions. Firms and companies have to pay taxes from the income they generate, and tax shield helps lower the taxes and spend it slowly throughout the years. Companies and businesses can get tax benefits through medical expenses, donations, interest expenses, depreciation, etc. One good example is buying a building instead of renting it. There is a low mortgage rate with the tax shields, so the companies and businesses have to reduce cash outflow.
Individuals
A tax shield is not only limited to companies or businesses, but it is also for individuals. Any individual can get tax benefits from medical expenses, donations, mortgage, interest expenses, depreciation, etc. One best example is a home loan. The interest that an individual pays on loan is tax-deductible. It means that the taxable income of an individual is lowered. Aside from that, the interest in student loans also serves as a tax shield. The interest that an individual pays on a student loan is also tax-deductible.
How to enjoy the Benefits of tax shield?
The best way to enjoy tax shields’ benefits is by considering a tax shield effect in all the financial decisions. Aside from tax savings, tax shields should also be considered when planning for a tax strategy. So here are the tips on how to enjoy the benefits of a tax shield.
Make advance tax planning. Do not wait for the year ends before you do the tax planning. Remember that some deductions are pro-rated, so you might not get the maximum savings when you buy late in the year.
Look for a good tax professional. An expert tax professional can help you increase tax shields and decrease taxes. It is essential to seek expert and professional help when handling tax shield concerns to prevent future frustrations.
Time your income and expenses. It is essential to identify the year in which you expect a high payment for taxes. Review the costs before the year ends and check the amounts that you want to deduct in your income. After that, you can increase your expenses and decrease your income through expenditures like stocking up supplies.
Use a tax shield for incentives. To maximize the benefits of a tax shield, you can use a home mortgage as a tax shield because it serves as a significant component in individuals’ or companies’ net worth. It gives incentives to individuals or corporations that are interested in buying a home with specific tax benefits.
Use a tax shield for medical expenses. If you are a taxpayer who paid more in the medical expenses covered by deduction, it can be itemized to gain a bigger tax shield. Therefore, you can deduct any amount to medical or dental expenses that you have.
Use a tax shield for depreciation. The deduction in depreciation allows taxpayers to regain losses related to the depreciation of any qualified property as it applies to tangible properties like buildings and vehicles. It is also applicable to intangible assets like patents and computer software. To maximize this tax shield benefit, the depreciation must have an asset used in income-generating activity and a lifespan of more than one year.
In every financial decision, maximizing the tax-saving benefits with tax shields plays a crucial role for individuals and companies. Keep in mind that you should not entirely depend on tax shields when making financial decisions. However, ignoring the tax shields may affect the value of the business or corporations. That is why the tax shield should always be taken into consideration.
