What Is a Tax Break?
The term tax break refers to a reduction of a taxpayer’s total liability. Tax breaks are made possible by tax laws and often come in the form of credits or deductions or through the exclusion of certain types of income from an individual's state or federal tax return. In some cases, taxpayers don't have to take any action at all in order to get a tax break. The term is also used to refer to the favorable tax treatment of any class of people in the United States. If the government gives a tax break to a particular group of people or type of organization, then it reduces the amount of tax they otherwise would have to pay or changes the tax system in a way that benefits them.
- A tax break is the reduction of a taxpayer’s total tax liability.
- Tax breaks are the result of tax laws.
- A tax deduction reduces the amount of gross income that is subject to taxes.
- A tax credit offsets the taxpayer’s liability on a dollar-for-dollar basis.
- A tax exemption shields a portion of income from taxation.
How Tax Breaks
The government provides individual and corporate taxpayers with tax breaks. These are ways that taxpaying entities can greatly reduce their tax liabilities. These savings may be enabled through tax credits, deductions, or tax exemptions.
In certain cases, taxpayers must meet certain income thresholds and claim credits and/or deductions to qualify for tax breaks to reduce their taxable income. The Saver's Tax Credit for retirement savings and tax deductions for charitable donations are generally considered tax breaks. Some instances don't require any action to get a tax break, which means they automatically qualify for income exclusion. For example, the death benefit from a life insurance policy is excluded from a person's taxable income.
Tax breaks are often explained as a means to stimulate the economy by increasing the amount that taxpayers have to spend or that businesses have to invest in their growth. They also are used to promote certain types of behaviors that are seen as beneficial, such as the replacement of gas-guzzling cars with modern fuel-efficient vehicles.
As noted above, tax breaks are implemented as a result of state and federal tax laws. These regulations outline how these tax breaks work, who qualifies, and (in some cases) how long they last. U.S. Congress and the president are responsible for approving federal income tax laws. For instance, Congress approved the Tax Cuts and Jobs (TCJA), which was signed into law in 2017 by then-President Donald Trump and made major changes to the U.S. tax code.
Charitable organizations and religious institutions are generally tax-exempt. This means they are not required to pay federal income taxes
Types of Tax Breaks
A tax credit reduces a taxpayer’s tax liability on a dollar-for-dollar basis. This has a greater impact than a deduction, which merely reduces the amount of income subject to taxes. A tax credit is applied to the amount of tax a taxpayer owes after all deductions are made from their taxable income. If an individual owes $3,000 to the government and is eligible for a $1,100 tax credit, then the amount owed is reduced to $1,900 after the tax break is applied.
Corporations can also take advantage of tax credits to lower their tax bills. The government permits these in order to help benefit workers and the national economy. Certain credits are implemented regardless of the industry or sector, such as business tax credits, investment credits, and credits for childcare for workers. They can also be more industry-specific, such as those in the agricultural, energy, and mining sectors.
Tax deductions are expenses that can be subtracted from your gross income to reduce taxable income. The reduction of taxable income is a tax break for the taxpayer, who ends up paying less to the government.
For example, if a single filer’s taxable income for the tax year is $75,000, then the person falls in the 22% marginal tax bracket for 2021 and 2022. The total marginal tax bill will be 22% × $75,000 = $16,500. But if they qualify for an $8,000 tax deduction, then the income taxed will be $75,000 - $8,000 = $67,000 taxable income—not $75,000. This reduces the person’s tax bill to $14,740.
An exemption screens a certain portion of income or type of income from taxation. For example, expatriates who earn income in a foreign country are eligible for a tax break through the foreign earned income exclusion (FEIE). The total for an individual is $108,700 for the 2021 tax year. So an ex-pat who earns $180,000 for a job in a foreign country, for example, will be taxed only on the amount that exceeds $108,700, or $71,300.