What is a depreciation tax shield?
In general, a tax shield is anything that reduces the taxable income for personal taxation or corporate taxation. Depreciation is considered a tax shield because depreciation expense reduces the company’s taxable income. When a company purchased a tangible asset, they are able to depreciation the cost of the asset over the useful life. Each year, this results in some amount of depreciation expense for tax purposes.
The formula for calculating a depreciation tax shield is easy. All you need to do is multiply depreciation expense for tax purposes (not financial purposes) and multiply by the effective income tax rate. The result equals the depreciation tax shield as the company will pay lower taxes.
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