What is a Tax Shield?

A tax shield can be a means by which either individuals or businesses reduce their overall tax owed. There are numerous types of tax shields. For individuals, especially in the middle class or above, having to pay interest on a home mortgage is considered a tax shield. Businesses may take on debt of many kinds in order to create a tax shield of some of their income.

Use of a tax shield proves that debt is not always a bad thing, particularly when the interest is tax deductible. For instance, in the US, home mortgages allow homeowners to lower the amount of income that is considered taxable, by being able to deduct a portion of the amount of money they make in interest payments. This difference can help people be able to afford homes, since they can count on lower tax payments and greater amounts of net income.

A renter, in contrast, wouldn’t be able to “shield” their income in the same manner, though some states offer small amounts of tax credits called renter’s credits. The difference though is usually much smaller than what can be made by claiming interest payments as tax deductible. Having to make mortgage and interest payments on a home loan is usually a better tax shield than renting, especially if your income is significantly reduced through taxes.

Other forms of the tax shield include being able to deduct medical expenses, reduced value of property, or charitable donations. Businesses can make further use of shields if they post large losses for a year. In fact, some huge businesses will continue to support a losing part of their business because it shields their taxable income for more profitable business concerns they have. Businesses have to weigh whether the loss of income from one source is greater than the tax they would have to pay on income from other sources.

Not all interest on debt is tax deductible and provides a shield. For individuals, main types of shields can include home mortgage interest, charitable donations, medical expenses, and losses in investments (including investments on real estate). Usually you won’t be able to deduct interest deriving from credit cards, car loans (unless the car is used for a business), or personal loans. This can vary depending upon the tax laws in your state or country. You can also count on a certain amount of your income being shielded from taxes through various allowable deductions like personal deductions, deductions for child care or child education expenses, and things like a child tax credit.

It can take some skillful planning to take advantage of a tax shield. People or businesses that know they will owe a lot in taxes often turn to financial advisors or accountants to help them figure out ways to reduce these taxes through shields and tax shelters. Since so many different shield laws can apply, it is usually best to work with a knowledgeable financial planner or accountant to reduce taxes as far as possible.