What Is a Tax Break?
A tax break is a savings on a taxpayer's liability. It is also used to refer to favorable tax treatment of any class of persons in the United States. If the government gives a tax break to a particular group of people or type of organization, it reduces the amount of tax they have to pay or changes the tax system in a way that benefits them.
Understanding Tax Breaks
Tax breaks are typically made available to stimulate the economy by increasing the amount of money taxpayers have to spend or to promote certain types of behaviors such as purchasing energy-efficient appliances or attending college. A tax break can greatly reduce a taxpayer's liability and provides savings through tax deductions, tax credits, tax exemptions, and other incentives.
Tax deductions are expenses that can be subtracted from gross income to reduce the taxable income of a taxpayer. If a single filer's taxable income for the tax year is $75,000 and they fall in the 25% marginal tax bracket, the total marginal tax bill will be 25% x $75,000 = $18,750. However, if they qualify for an $8,000 tax deduction, they will be taxed on $75,000 – $8,000 = $67,000 taxable income, not $75,000. The reduction of this taxable income is a tax break for the taxpayer who ends up paying less in taxes to the government.
A credit is a tax break that reduces a taxpayer's tax liability dollar-for-dollar and has a greater impact than deductions, which only reduces the amount of income subject to taxes. In effect, a tax credit is applied to the amount of tax owed by the taxpayer 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, they will only have to pay $1,900 after the tax break is applied.
Exemptions occur where a tax for a certain item or type of income is reduced or eliminated. This form of tax break allows a taxpayer to exclude a portion of his income from taxes or exclude certain types of income from his tax return. For example, expatriates who earn income in foreign countries have a tax break of $105,900 (as of 2019) which can be applied through the Foreign Earned Income Exclusion (FEIE). The FEIE allows expats to exclude $105,900 of their foreign income from their tax returns. An expat that earns, say $180,000, from his job in a foreign country that is tax free will only need to pay U.S. federal income tax on $180,000 – $105,900 = $74,100, not the entire $180,000.