Tax Shields

Lesson:

A tax shield is a method to reduce taxable income through the use of deductions. In many cases, the deduction is due to interest payments from debt.

The formula we use is: TAX SHIELD = TAX RATE X INTEREST EXPENSE

You're a tax accountant looking at a firm's use of debt as a tax shield.

Here are the relevant facts:

  • The interest expense is $6,000.00.
  • The tax rate is 0.16.
What is the tax shield?

Answer:

  • The tax shield is $960.00.

Explanation:

  1. First, let's remember the formula we need:
    TAX SHIELD = INTEREST EXPENSE × TAX RATE
  2. Next, let's plug in the numbers that we know. The order that we fill in the numbers doesn't matter.
  3. Let's plug in the interest expense.
    TAX SHIELD = $6,000.00 × TAX RATE
  4. Let's plug in the tax rate.
    TAX SHIELD = $6,000.00 × 0.16
  5. Finally, we just have to solve for tax shield.
    TAX SHIELD = $960.00
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