We can call it as a medium of reducing tax liability. The tax shield lowers the assessable income by an amount that we can deduct from it. These expenses allowed as deductions are multiplied by a tax rate. This resultant figure is the tax shield for such tax liability. The tax rate and allowable expenses may vary from country to country. Also, the expenses are a bit different for individuals and business corporates. A tax shield calculator is simply an online tool for calculating this quantum of the tax shield.
One pays tax to the government on their earnings. The tax liability will be more if nothing is allowed as a deduction from these earnings. Hence, this tax shield works as a shield against higher tax liability.
Let’s take a simple example to understand this better. Assume that a company is planning to acquire an asset. Now, if the company buys it directly for cash, the total income generated from it will become taxable after getting a deduction of depreciation. But the company has decided to take a loan to buy this asset. Now, along with the deduction of depreciation, it will also get a deduction on the interest amount.
The formula for calculating tax shield is as follows:
Tax Shield = Deductible Expenses * Tax Rate
How to Calculate using Calculator?
Enter the following two variables for calculating the tax shield:
All the expenses which are allowed as deductions from the income for the purpose of calculating the ultimate tax liability are deductible expenses. These expenses include depreciation, donation/charity, interest on borrowings, medical expenses and insurance, rent, etc.
Enter the tax rate applicable for assessing the tax liability. We multiply this rate by the deductible expenses to determine the amount that we reduce or are likely to save from the tax liability.
Let us continue with the above example where the company has bought the asset on the loan of $200,000 @ 4% p.a., and the depreciation amounts to $45,000 each year. The tax rate for the company is 30%.
Interest = 8,000 (i.e., 200,000*4%)
Tax Shield = (8,000 + 45,000) * 30% = $15,900
So the total tax shied or tax savings available to the company will be $15900 if it purchases the asset through a financing arrangement. Else this figure would be less by $ 2400 ($8000*30% tax rate), as only depreciation would remain the deductible expenses.
This tax shield goes a long way, as it reduces the tax liability as well as the cash outflow to that extent.