Getting a tax exemption can be a boon. A tax exemption either reduces or eliminates a portion of your income from being taxed. Federal, state, and local governments create tax exemptions to provide a benefit for specific people, businesses, or other entities in special situations. Those who are entitled to them save on taxes because they're allowed to subtract some of their income from top-line income. Here’s a look at the different kinds of tax exemptions.
- A tax exemption is an amount that is subtracted from a taxpayer's taxable income, reducing the amount of taxes they owe.
- The most familiar tax exemption is the federal standard deduction, though certain individuals claim the itemized deduction instead.
- State and local tax filings often have less well-known exemptions.
- Tax exemptions encourage or shelter a particular group of people by providing them with a tax benefit.
- The agency that issues the exemption often requires taxpayers to list their gross income and their deductions, then calculate tax on the net figure.
Primary Federal Income Tax Exemptions
Federal tax law gives each individual or family this deduction just for being taxpayers who file returns. The premise of the standard deduction is that every taxpayer has a portion of their income that is tax-free. The standard deduction is driven by a taxpayer's federal income tax filing status. The IRS announces these amounts each year and adjusts them annually based on inflation.
The table below outlines the standard deduction for each filing status.
|Married Filing Separately||$12,950||$13,850|
|Head of Household||$19,400||$19,400|
|Married Filing Jointly||$25,900||$27,700|
|Qualifying Surviving Spouse||$25,900||$27,700|
An itemized deduction is an alternative to the standard deduction. A taxpayer may claim one or the other—not both. Tax rules permit specific types of transactions to be deducted from a taxpayer's income. If a taxpayer incurs enough of these transactions (or incurs just one very large transaction), it may be more favorable for them to elect an itemized deduction as opposed to the standard deduction.
Examples of itemized deduction categories include:
- The mortgage interest paid on a home
- State income taxes
- Local income taxes
- Sales tax returns
- Property taxes
- Medical and dental expenses that exceed 7.5% of the taxpayer's adjusted gross income (AGI)
- Charitable contributions
Tax authorities will often require taxpayers to report both their gross income and their tax exemptions as opposed to only reporting a single net number.
Property Tax Exemptions
State and local governments may give property owners certain exemptions from real estate taxes owed on their property. The exemptions are designed to reward or protect certain classes of homeowners by reducing the amount of taxes paid on the property. Here are some common property tax exemptions:
- Homestead: This exemption is for taxpayers who own a home that they use as their principal residence in a state or municipality that wishes to encourage that. For example, Florida offers a homestead exemption of up to $50,000 to homeowners who are Florida residents. The exemption is not available to those who own vacation homes in the state.
- Age and Disability: Seniors and the disabled qualify for property tax reductions in some localities. Age alone may not be sufficient. You may need to demonstrate a financial need to qualify. Even the definition of the term senior varies by locality. For instance, Washington State offers a senior exemption from age 61, as well as for veterans and disabled retirees while other states may have different thresholds for this age.
- Public Service: Military veterans may claim a property tax exemption in some localities, though some restrict the eligibility to disabled veterans. The exemption may continue for the surviving spouse or parents. Some localities offer exemptions for volunteers. For example, New York gives exemptions to volunteer firefighters and ambulance workers.
These are just examples of the exemptions that may be available in some states and municipalities. Others are available for people renovating old houses, installing renewable energy systems, or surviving a spouse.
State and local tax exemptions may benefit veterans, senior citizens, or people with disabilities.
Some exemptions are limited to a portion of property taxes. For example, the New York State School Tax Relief exemption, which is no longer available to new applicants, applies only to the school tax portion of the bill.
Taking one exemption does not preclude a taxpayer from taking others. For example, a Miami homeowner who takes the homestead exemption might also qualify for other exemptions if they are a disabled veteran.
Property tax exemptions are not automatic. Homeowners must apply for them and demonstrate their eligibility.
Charities, fraternities, labor organizations, trade associations, churches, and other entities operate for a specific purpose that does not include making a profit. The law lets these entities operate without any income tax obligation on the money they receive. They pay employment taxes for their staff, just as for-profit businesses do.
Tax-exempt status means that the funds they raise are not treated as income that would be taxed but rather as contributions that are not taxed.
Exemptions vs. Credits
Some taxpayers may receive both exemptions and credits on certain tax returns. Both are generally favorable for the taxpayer, but each has a different mechanism for benefiting the filer.
Tax exemptions reduce the amount of income you owe tax on. Instead of having to pay taxes on your gross earnings, you're allowed to subtract certain figures from this amount to arrive at your AGI. For example, if you earned $100,000 last year but are eligible for a $5,000 deduction, your taxable income is $95,000.
Tax credits, on the other hand, directly impact the amount of tax you are assessed. Say the applicable tax table dictates that $95,000 of taxable income is assessed at $15,000 of tax. A tax credit of $1,000 would reduce the amount of taxes owed to $14,000. Non-refundable tax credits can reduce the amount of tax owed to $0 while refundable tax credits can create a tax refund for the taxpayer.
Why Do I Have to Fill Out Form W-4?
IRS Form W-4 is called the Withholding Certificate. You must complete this form in order to tell your employer how much federal tax must be withheld from your paycheck. A new form must be filled out every time you change employers or whenever your personal situation changes. For instance, you may consider filing a new form if your marital status changes or if you have a new baby.
Is It Better to Claim 0 or 1 Exemptions on a W-4?
Taxpayers who list a lower number of exemptions on their W-4 will have more money automatically withheld from their paychecks for taxes. Taxpayers who report 0 exemptions on their W-4 will have the most amount of tax automatically withdrawn.
What Organizations Are Exempt From Tax?
The IRS permits companies that meet certain criteria under Internal Revenue Code Section 501(c)(3) to be exempt from federal tax. These organizations include but are not limited to religious, charitable, scientific, literary, educational, or other specific types of entities.
The Bottom Line
Taxpayers often do not pay taxes on the gross or full amount of revenue they earned. This is because some or all of this income may be exempt from taxes. Tax exemptions are built into tax codification to provide benefits to certain demographics, individuals who recently entered into specific types of transactions, or specific legal entities. Tax exemptions work by reducing the income basis in which income tax is calculated.
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2022."
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."
Internal Revenue Service. "Topic No. 501 Should I Itemize?"
Internal Revenue Service. "Form 1040."
Florida Department of Revenue. "Property Tax Exemption for Homestead Property."
Washington State Department of Revenue. "Property Tax Exemption Program for Senior Citizens and Disabled Persons.'
New York State Department of Taxation and Finance. "Volunteer Firefighters' and Ambulance Workers' Credit."
New York State Department of Taxation and Finance. "STAR Resource Center."
Internal Revenue Service. "Exempt Organization Types."
Internal Revenue Service. "Applying for Tax Exempt Status."
Internal Revenue Service. "Credits and Deductions for Individuals."
Internal Revenue Service. "Form W-4," Page 2.
Internal Revenue Service. "Exempt Organization Types."