Taxes are an unavoidable part of doing business, often cutting into annual revenue and making it difficult to grow. However, savvy business owners realize that one of the best ways to reduce that tax burden is with tax deductions. With careful tracking of expenses throughout the year, your business can enjoy dramatic tax savings and keep more of your earnings each year.
What Is a Tax Shield?
“Tax shield” is another term for those deductions, whether they apply to personal or business tax filings. For businesses, tax shields cover the day-to-day expenses, including costs like travel, office supplies and electronics. But some businesses take a more deliberate approach to setting up a tax shield. For those businesses, purchases are carefully planned to reduce their tax burden during a year where their income will be higher, forcing them to pay a higher tax rate.
Leased Equipment as a Tax Shield
There are many types of expenses that can qualify as deductions, each of which includes items you likely buy already. In addition to expenses, businesses can also deduct the cost of leased equipment. However, it’s important to calculate the tax benefits of ownership versus leasing before making that decision. There are two main types of business leases: a capital lease and an operating lease. With an operating lease, your company may get a bigger tax break, especially if the leased item will become obsolete before it depreciates off your books. Capital leases let you expense any interest you pay, as well as depreciating the cost of that item over its lifetime. To qualify as a capital lease, the term must be greater than 75 percent of the life of the asset, the lease must transfer to the lessee at the end of the agreement and payments must be greater than 90 percent of the equipment’s value or the lessor must include a discounted price as part of the purchase.
How Do You Calculate a Tax Shield?
Although the corporate tax rate can vary, generally you’ll pay between 15 percent and 35 percent. To calculate your tax shield, first find the total cost of the deduction for the entire year, then multiply that cost by your estimated tax rate. This gives you a good idea of the tax shield on that item. If you have $1,000 in interest expense for the year, with a 35 percent tax rate, your tax shield would be $350.
Although the laws surrounding business taxes can be complicated, with enough research, a business can easily reduce its tax debt each year. Thanks to tax shields, professionals can get benefits out of items they would have needed to purchase anyway.