What Is a Tax Break?
The term tax break refers to a benefit the government offers that reduces your total tax liability. Tax breaks are made possible by tax laws and typically come in the form of credits and deductions. Other tax breaks include exemptions and excluding certain types of income from your state or federal tax return.
Tax breaks also refer to the favorable tax treatment certain groups receive. Churches and religious organizations, for example, are generally exempt from federal, state, and local income and property taxes, among other tax perks. Likewise, people affected by natural disasters receive tax breaks in the form of filing and payment extensions, penalty and interest waivers, and deductions for casualty and theft losses.
- Tax breaks such as credits and deductions lower your total tax liability.
- Tax breaks are the product of tax laws designed to strengthen the economy or promote specific policy goals.
- Tax breaks are also specifically designed to promote specific economic activity (i.e. there are tax incentives for getting a secondary education).
- A tax credit offsets your tax liability on a dollar-for-dollar basis, and some refundable tax credits may reduce your liability below $0 and into a refund.
- A tax deduction reduces the amount of gross income that is subject to taxes.
How Tax Breaks Work
In some cases, you don't have to take any action to get a tax break. For example, life insurance proceeds you receive are generally excluded from your taxable income—and you don't have to report them. However, to take advantage of most tax breaks, you must claim them (e.g., tax credits or deductions) on your income tax return and meet specific eligibility requirements.
The personal exemption was a federal tax break up until 2017. Under the Tax Cuts and Jobs Act, the personal exemption deduction is suspended (reduced to $0) for tax years 2018 through 2025.
Tax breaks can stimulate the economy by increasing the amount taxpayers have to spend and boosting what businesses can invest in their growth. Moreover, tax breaks can promote certain behaviors that benefit society, such as replacing gas-guzzling cars with modern fuel-efficient vehicles.
As noted above, tax breaks are implemented because of state and federal tax laws. Regulations outline how tax breaks work, who qualifies, and (in some cases) how long the tax break lasts. The U.S. Congress and the president are responsible for approving federal income tax laws. For instance, Congress approved the Tax Cuts and Jobs Act (TCJA), which made significant changes to the U.S. tax code and was signed into law in 2017 by then-President Donald Trump.
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 your 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 you owe after all deductions are taken from your taxable income. For example, if you owe $3,000 in taxes and are eligible for a $1,100 tax credit, the amount you owe decreases to $1,900 ($3,000 - $1,100) after the tax break is applied.
Tax credits lower your tax bill on a dollar-for-dollar basis. On the other hand, tax deductions reduce your taxable income—or the amount of income on which your taxes are calculated. Tax credits are worth more than deductions because they directly reduce your tax bill.
Corporations can also take advantage of tax credits to lower their tax bills. The government permits these to 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 child care 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 your taxable income—and therefore, your tax bill. For example, a $1,000 tax deduction would lower your taxable income by that same amount. The value of the deduction depends on your tax bracket. So, if you are in the 22% tax bracket, that $1,000 tax deduction would save you $220 ($1,000 × 22%) on your tax bill.
Most taxpayers have the option to take the standard deduction (a fixed dollar amount based on your filing status) or itemize their deductions on Schedule A of Form 1040 or 1040-SR. Here's a rundown of the standard deduction amounts for 2022 and 2023:
|Standard Deductions for 2022 and 2023|
|Filing Status||2022 Standard Deduction||2023 Standard Deduction|
|Married Filing Separately||$12,950||$13,850|
|Heads of Household||$19,400||$20,800|
|Married Filing Jointly||$25,900||$27,700|
Deductions you can itemize include:
- Mortgage interest on the first $750,000 of secured mortgage debt (or $1 million if you bought the home before Dec. 16, 2017)
- Unreimbursed medical and dental expenses that total more than 7.5% of your adjusted gross income (AGI)
- Up to $10,000 in state and local taxes
- Charitable contributions
- Casualty and theft losses
- Gambling losses
If the sum of the deductions you can itemize exceeds your standard deduction, it makes financial sense to itemize.
A tax exclusion shelters a certain portion of income or type of income from taxation. For example, you can generally exclude child support payments, life insurance proceeds, and municipal bond income from your taxable income. Likewise, health insurance premiums your employer pays are exempt from federal income and payroll taxes, and the portion of premiums you pay is generally excluded from your taxable income.
Another common tax exclusion pertains to home sales. If you have a capital gain from selling your main home, you can exclude up to $250,000 ($500,000 if married filing jointly) of that gain from your income. To qualify, you must:
- Have owned and lived in the home for at least two out of the previous five years
- Not have excluded the gain from the sale of another home within the past two years
Also, if you earn income in a foreign country, you may be eligible for a tax break through the foreign earned income exclusion. The total for an individual is $112,000 for the 2022 tax year and $120,000 for the 2023 tax year.
What Is the Difference Between Tax Credits and Tax Deductions?
Tax credits and tax deductions both save you money at tax time, but credits are more favorable. Tax credits lower the amount of tax you owe—dollar for dollar—while tax deductions reduce your taxable income. For instance, a $1,000 tax credit cuts $1,000 off your tax bill, and a $1,000 tax deduction lowers your taxable income by $1,000. So, if you fall into the 22% tax bracket, a $1,000 deduction would reduce your tax bill by $220.
Are Tax Credits Better Than Tax Deductions?
Many tax credits may yield better favorable results compared to tax deductions, especially if those tax credits are refundable. Refundable tax credits can reduce a taxpayer's liability below $0 and result in a refund. While tax deductions can only limit the taxability of an individual's income, some tax credits actually return a refund.
What Is the Annual Gift Exclusion for 2022?
The annual exclusion for gifts is $16,000 for 2022 and $17,000 in 2023. That means you can give up to $16,000 or $17,000 tax-free to as many people as you wish without using any of your lifetime gift and estate tax exemption.
Who Qualifies for Tax Breaks?
Broadly speaking, many tax breaks favor individuals with lower income. Many tax deductions and credits phase-out as an individuals income increases, meaning a person may only receive a partial amount of a tax break. Eventually, taxpayers with income "too high" will not quality for certain tax breaks.
In addition, many tax breaks are designed for specific economic activity. For example, to incentive workers to contribute to their retirement accounts, certain contributions may receive favorable tax treatment. These types of tax breaks can be obtained by simply engaging in the qualification requirement.
The Bottom Line
The ultimate goal of many is to reduce their tax liability owed to the federal government. Individuals, corporations, and nonprofit entities all leverage tax breaks that exclude some income from being taxable, allow for parts of net income to be deductible, and permit certain credits to directly reduce taxes owed. In general, it's advisable to pursue tax breaks to limit your tax exposure.
Internal Revenue Service. "Tax Information for Churches and Religious Organizations."
Internal Revenue Service. "Credits and Deductions for Individuals."
Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Pages 22-23, 30.
Internal Revenue Service. "Tax Reform Provisions That Affect Individuals."
Internal Revenue Service. "Publication 5307, Tax Reform Basics for Individuals and Families."
Internal Revenue Service. "Churches, Integrated Auxiliaries, and Conventions or Associations of Churches."
Internal Revenue Service. "Exemption Requirements - 501(c)(3) Organizations."
Internal Revenue Service. "Business Tax Credits."
Internal Revenue Service. “Credits and Deductions for Individuals.”
Internal Revenue Service. “Rev. Proc. 2021-45," Page 14.
Internal Revenue Service. “Rev. Proc. 2022-45."
Internal Revenue Service. "Publication 936 (2021), Home Mortgage Interest Deduction."
Internal Revenue Service. “Topic No. 502 Medical and Dental Expenses."
Internal Revenue Service. "Employee Benefits."
Internal Revenue Service. "Topic No. 701 Sale of Your Home."
Internal Revenue Service. "Foreign Earned Income Exclusion."
Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."
Tax Deductions and Credits Guide
What Is Tax Relief? How It Works, Types, and Example
Tax Benefit: Definition, Types, IRS Rules
Tax Break Definition, Different Types, How to Get One
Tax Deductions That Went Away After the Tax Cuts and Jobs Act
Tax Credits That Can Get You a Refund
Non-Refundable Tax Credit: Definition, How It Works, and Benefits
Earned Income Tax Credit (EITC): Definition and How to Qualify
Saver’s Tax Credit: A Retirement Savings Incentive
Unified Tax Credit: Definition and Limits for 2022
General Business Credit (GBC)
Foreign Tax Credit: Definition, How It Works, Who Can Claim It
Dependents: Definition, Types, and Tax Credits
How Much Does a Dependent Reduce Your Taxes?
Child and Dependent Care Credit Definition
Child Tax Credit Definition: How It Works and How to Claim It
Additional Child Tax Credit (ACTC): Definition and Who Qualifies
What Was the Hope Credit? How It Worked and Replacement
American Opportunity Tax Credit (AOTC): Definition and Benefits
Tax Deduction Definition: Standard or Itemized?
Itemized Deductions: What It Means and How to Claim
Tax-Deductible Interest: Definition and Types That Qualify
Charitable Contribution Deduction: Rules and Changes for 2022 and 2023
20 Medical Expenses You Didn’t Know You Could Deduct
Educator Expense Deduction
Top Tax Advantages of Buying a Home
Calculating the Home Mortgage Interest Deduction (HMID)
Tax Breaks for Second-Home Owners
Rental Property Tax Deductions
Getting U.S. Tax Deductions on Foreign Real Estate
401(k) vs. IRA: What’s the Difference?
IRA Contributions: Deductions and Tax Credits