What is an 'Exemption'
An exemption is a deduction allowed by law to reduce the amount of income that would otherwise be taxed. The Internal Revenue Service (IRS) offers two types of exemptions: personal and dependent exemptions. An example of an exemption is the reduction in taxes granted for dependent children (under the age of 18) living with the tax filer.
BREAKING DOWN 'Exemption'
As of 2015, the IRS allows tax filers to claim $4,000 for each of their allowable exemptions. For example, a taxpayer who has three allowable exemptions may deduct $12,000 from his taxable income. However, if he earns over a certain threshold, the amount of the exemption he can claim is slowly phased out and eventually eliminated. As of 2015, single tax filers earning over $258,250 and married taxpayers earning over $309,900 receive lowered exemptions.
Tax filers may only claim a personal exemption if they are not claimed as a dependent on someone else's income tax return. This rule sets exemptions apart from deductions. Every tax filer is allowed to claim a personal deduction.
For example, imagine you are a college student with a job and your parents claim you as a dependent on their income tax return. Because someone else claims you as a dependent, you cannot claim the personal exemption, but you may claim the standard deduction. If you earned $12,000, you can claim the standard deduction of $6,300. That reduces your taxable income to $5,700. If you were also able to claim the personal exemption, your taxable income would be lowered to $1,700.
In most cases, tax filers may also claim a personal deduction for their spouses, as long as the spouse is not claimed as a dependent on another person's tax return.
In many cases, dependents are minor children of the taxpayer, but taxpayers may claim exemptions for other dependents as well. The IRS has a litmus test for determining who is considered a dependent, but in most cases, it is defined as a relative of the taxpayer (parent, child, brother, sister, aunt or uncle) who is dependent on the taxpayer for his support.
Exemption From Withholding
Employers withhold income tax from their employees and remit it to the IRS. However, if a person has no tax liability, he can request an exemption from withholding. This simply means that his boss withholds Medicare and Social Security contributions from his paycheck, but does not withhold income tax.