What is a Tax Shield?

A tax shield is a deduction, credit or other method used to reduce the amount of taxes owed.

How Does a Tax Shield Work?

For example, let's say John and his wife have a baby in 2011. When John files his tax return for the year 2011, he qualifies for a $1,000 child tax credit, which lowers his tax bill by $1,000. In other words, John's baby is a tax shield.

There are hundreds of different tax shields available to individuals and companies, though the tax shields are usually available only under certain circumstances. For example, some tax shields are only available to low-income taxpayers or taxpayers who own a home.

Why Does a Tax Shield Matter?

Tax shields lower tax bills, which is why taxpayers spend a considerable amount of time determining which deductions and credits they qualify for each year. Governments often create tax shields as a way to encourage certain behavior or investment in certain industries or programs. For example, the mortgage interest deduction is a tax shield meant to increase homeownership in the U.S.