Financial Terms Tax shield

# Definition of Tax shield

## Tax shield

The reduction in income taxes that results from taking an allowable deduction from taxable income.

# Related Terms:

## Depreciation tax shield

The value of the tax write-off on depreciation of plant and equipment.

## depreciation tax shield

Reduction in taxes attributable to the depreciation allowance.

## Interest tax shield

The reduction in income taxes that results from the tax-deductibility of interest payments.

## interest tax shield

tax savings resulting from deductibility of interest payments.

## tax shield (of depreciation)

the amount of depreciation deductible
for tax purposes; the amount of revenue shielded
from taxes because of the depreciation deduction

The net present value analysis of an asset if financed solely by equity
(present value of un-levered cash flows), plus the present value of any financing decisions (levered cash
flows). In other words, the various tax shields provided by the deductibility of interest and the benefits of
other investment tax credits are calculated separately. This analysis is often used for highly leveraged
transactions such as a leverage buy-out.

## Pro forma capital structure analysis

A method of analyzing the impact of alternative capital structure
choices on a firm's credit statistics and reported financial results, especially to determine whether the firm will
be able to use projected tax shield benefits fully.

## Safe harbor lease

A lease to transfer tax benefits of ownership (depreciation and debt tax shield) from the
lessee, if the lessee could not use them, to a lessor that could use them.

## Static theory of capital structure

Theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.

Debt levels are chosen to balance interest tax shields against the costs of financial distress.

## After-tax profit margin

The ratio of net income to net sales.

## After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

## Asymmetric taxes

A situation wherein participants in a transaction have different net tax rates.

## Average tax rate

taxes as a fraction of income; total taxes divided by total taxable income.

## average tax rate

Total taxes owed divided by total income.

## Before-tax profit margin

The ratio of net income before taxes to net sales.

## Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.

## Cash flow after interest and taxes

Net income plus depreciation.

## Corporate tax view

The argument that double (corporate and individual) taxation of equity returns makes
debt a cheaper financing method.

## Corporate taxable equivalent

Rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

## Current Income Tax Expense

That portion of the total income tax provision that is based on
taxable income.

## Current Tax Payment Act of 1943

A federal Act requiring employers to withhold income taxes from employee pay.

## Deferred Income Tax Expense

That portion of the total income tax provision that is the result
of current-period originations and reversals of temporary differences.

## Deferred Tax Asset

Future tax benefit that results from (1) the origination of a temporary difference
that causes pretax book income to be less than taxable income or (2) a loss, credit, or other
carryforward. Future tax benefits are realized on the reversal of deductible temporary differences
or the offsetting of a loss carryforward against taxable income or a tax-credit carryforward against
the current tax provision.

## Deferred Tax Liability

Future tax obligation that results from the origination of a temporary
difference that causes pretax book income to exceed taxable income.

## Deferred taxes

A non-cash expense that provides a source of free cash flow. Amount allocated during the
period to cover tax liabilities that have not yet been paid.

## Double-tax agreement

Agreement between two countries that taxes paid abroad can be offset against
domestic taxes levied on foreign dividends.

## earnings before interest and income tax (EBIT)

A measure of profit that
equals sales revenue for the period minus cost-of-goods-sold expense
and all operating expenses—but before deducting interest and income
tax expenses. It is a measure of the operating profit of a business before
considering the cost of its debt capital and income tax.

## Earnings before interest and taxes (EBIT)

A financial measure defined as revenues less cost of goods sold
and selling, general, and administrative expenses. In other words, operating and non-operating profit before
the deduction of interest and income taxes.

## Earnings before interest and taxes (EBIT)

The operating profit before deducting interest and tax.

## Earnings before interest, taxes, depreciation and amortization (EBITDA)

The operating profit before deducting interest, tax, depreciation and amortization.

## Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

An earningsbased measure that, for many, serves as a surrogate for cash flow. Actually consists of working
capital provided by operations before interest and taxes.

## EBDDT - Earnings before depreciation and deferred taxes

This measure is used principally by
firms in the real estate industry, with the exception of real estate investment trusts, which typically
do not pay taxes.

## Effective Tax Rate

The total tax provision divided by pretax book income from continuing
operations.

## Electronic Federal Tax Payment Systems (EFTPS)

An electronic funds transfer system used by businesses to remit taxes to the government.

## Equivalent taxable yield

The yield that must be offered on a taxable bond issue to give the same after-tax
yield as a tax-exempt issue.

## Federal Unemployment Tax Act (FUTA)

A federal Act requiring employers to pay a tax on the wages paid to their employees, which is then used to create a
pool of funds to be used for unemployment benefits.

## Foreign tax credit

Home country credit against domestic income tax for foreign taxes paid on foreign
derived earnings.

## Imputation tax system

Arrangement by which investors who receive a dividend also receive a tax credit for
corporate taxes that the firm has paid.

## INCOME TAX

What the business paid to the IRS.

## Income tax

A government tax on the income earned by an individual or corporation.

## Income Tax Expense

See income tax provision.

## Income Tax Provision

The expense deduction from pretax book income reported on the
income statement. It consists of both current income tax expense and deferred income tax
expense. The terms income tax expense and income tax provision are used interchangeably.

## Indirect Taxes

taxes paid by consumers when they buy goods and services. A sales tax is an example.

## Inflation Tax

The loss in purchasing power due to inflation eroding the real value of financial assets such as cash.

## Interest equalization tax

tax on foreign investment by residents of the U.S. which was abolished in 1974.

## Investment tax credit

Proportion of new capital investment that can be used to reduce a company's tax bill
(abolished in 1986).

## Investment Tax Credit

A reduction in taxes offered to firms to induce them to increase investment spending.

## Limited-tax general obligation bond

A general obligation bond that is limited as to revenue sources.

## Margin Tax Rate

The tax rate applicable to the last unit of income.

## Marginal tax rate

The tax rate that would have to be paid on any additional dollars of taxable income earned.

## Marginal Tax Rate

Percent of an increase in income paid in tax.

## Payroll tax expense

The amount of tax associated with salaries that an employer pays to governments (federal, state, and local).

## Payroll taxes payable

The amount of payroll taxes owed to the various governments at the end of a period.

## Personal tax view (of capital structure)

The argument that the difference in personal tax rates between
income from debt and income from equity eliminates the disadvantage from the double taxation (corporate
and personal) of income from equity.

See EBIT.

## Progressive Tax

A tax in which the rich pay a larger percentage of income than the poor. Contrast with regressive tax.

## Progressive tax system

A tax system wherein the average tax rate increases for some increases in income but
never decreases with an increase in income.

## Proportional Tax

A tax taking the same percentage of income regardless of the level of income.

## Regressive Tax

A tax in which the poor pay a larger percentage of income than the rich. Contrast with progressive tax.

circumstances.

## Sales Tax

A tax levied as a percentage of retail sales.

## Short-term tax exempts

Short-term securities issued by states, municipalities, local housing agencies, and
urban renewal agencies.

## Split-rate tax system

A tax system that taxes retained earnings at a higher rate than earnings that are
distributed as dividends.

## State Disability Tax

A tax charged by selected states to maintain a disability insurance
fund, from which payments are made to employees who are unable to
work due to illness or injury.

## Statutory Tax Rate

The income tax rate that is stated in income tax law. It is applied to taxable
income reported in income tax returns. The U.S. Federal statutory corporate income tax rate
starts out at 15% for taxable income up to \$50,000 and rises quickly to 35%.

## TANs (tax anticipation notes)

tax anticipation notes issued by states or municipalities to finance current
operations in anticipation of future tax receipts.

## Tax anticipation bills (TABs)

Special bills that the Treasury occasionally issues that mature on corporate
quarterly income tax dates and can be used at face value by corporations to pay their tax liabilities.

## tax benefit (of depreciation)

the amount of depreciation deductible for tax purposes multiplied by the tax rate;
the reduction in taxes caused by the deductibility of depreciation

## Tax books

Set of books kept by a firm's management for the IRS that follows IRS rules. The stockholder's
books follow Financial Accounting Standards Board rules.

## Tax clawback agreement

An agreement to contribute as equity to a project the value of all previously
realized project-related tax benefits not already clawed back to the extent required to cover any cash
deficiency of the project.

## tax deferral

postponing taxation of an amount until a future date

## Tax deferral option

The feature of the U.S. Internal Revenue Code that the capital gains tax on an asset is
payable only when the gain is realized by selling the asset.

## tax-deferred income

current compensation that is taxed at a future date

## Tax-deferred retirement plans

Employer-sponsored and other plans that allow contributions and earnings to
be made and accumulate tax-free until they are paid out as benefits.

## Tax differential view ( of dividend policy)

The view that shareholders prefer capital gains over dividends,
and hence low payout ratios, because capital gains are effectively taxed at lower rates than dividends.

## tax-exempt income

current compensation that is never taxed

## Tax-exempt sector

The municipal bond market where state and local governments raise funds. Bonds issued
in this sector are exempt from federal income taxes.

## tax exemption

a tax treatment where income is never subject to income taxation

## Tax free acquisition

A merger or consolidation in which 1) the acquirer's tax basis in each asset whose
ownership is transferred in the transaction is generally the same as the acquiree's, and 2) each seller who
receives only stock does not have to pay any tax on the gain he realizes until the shares are sold.

## Tax haven

A nation with a moderate level of taxation and/or liberal tax incentives for undertaking specific
activities such as exporting or investing.

## Tax Reform Act of 1986

A 1986 law involving a major overhaul of the U.S. tax code.

## Tax-Related Incomes Policy (TIP)

tax incentives for labor and business to induce them to conform to wage/price guidelines.

## Tax swap

Swapping two similar bonds to receive a tax benefit.

## Tax-timing option

The option to sell an asset and claim a loss for tax purposes or not to sell the asset and
defer the capital gains tax.

## Taxable acquisition

A merger or consolidation that is not a tax-fee acquisition. The selling shareholders are
treated as having sold their shares.

## Taxable income

Gross income less a set of deductions.

## Taxable Income

Income subject to income tax as reported on the tax return.

## Taxable transaction

Any transaction that is not tax-free to the parties involved, such as a taxable acquisition.

## Two-tier tax system

A method of taxation in which the income going to shareholders is taxed twice.

Method of indirect taxation whereby a tax is levied at each stage of production on the value

## Withholding tax

A tax levied by a country of source on income paid, usually on dividends remitted to the
home country of the firm operating in a foreign country. tax levied on dividends paid abroad.