A tax exemption reduces or eliminates a portion of your income from taxation. Federal, state, and local governments create tax exemptions to benefit people, businesses, and other entities in special situations. Those who are entitled save on taxes by reducing their top-line income.
Key Takeaways
- A tax exemption is an amount subtracted from a taxpayer's taxable income.
- The most common tax exemption is the federal standard deduction.
- State and local tax filings often have less well-known exemptions.
- The agency that issues the exemption requires taxpayers to list gross income and deductions first, and then calculate tax on the net figure.
Federal Income Tax Exemptions
Standard Deduction
Federal tax law gives each individual or family this deduction as taxpayers who file returns. The premise of the standard deduction is that every taxpayer enjoys a portion of their income 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:
| Filing Status | 2023 | 2024 |
| Single | $13,850 | $14,600 |
| Married Filing Separately | $13,850 | $14,600 |
| Head of Household | $19,400 | $21,900 |
| Married Filing Jointly | $27,700 | $29,200 |
| Qualifying Surviving Spouse | $27,700 | $29,200 |
Itemized Deduction
An itemized deduction is an alternative to the standard deduction. A taxpayer may claim one or the other but not both. Tax rules permit specific transactions to be deducted from a taxpayer's income. If a taxpayer incurs enough of these transactions, it may be more favorable for them to itemize their deduction as opposed to taking 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 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 exemptions from real estate taxes owed on their property. The exemptions are designed to reward or protect certain 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. Florida offers a homestead exemption of up to $50,000 to homeowners who are Florida residents, but it is not available to those who own vacation homes in the state.
- Age and Disability: These property tax reductions are available in some localities. Age alone may not be sufficient and individuals may need to demonstrate a financial need to qualify. Washington State offers an exemption for those over age 61, as well as for veterans and disabled retirees.
- 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.
Taking one exemption does not preclude a taxpayer from taking others. A Miami homeowner who takes the homestead exemption in Florida 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.
Tax-Exempt Organizations
Charities, fraternities, labor organizations, trade associations, churches,and other entities operate for a specific purpose that does not include making a profit. The law allows these entities to operate without any income tax obligation on the money they receive. However, 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 untaxed contributions.
Exemptions vs. Credits
Some taxpayers may file both exemptions and credits on certain tax returns. Both are generally favorable for the taxpayer, but each has a different mechanism to benefit the filer. Tax exemptions reduce the amount of income on which you owe tax. Instead of having to pay taxes on your gross earnings, you're allowed to subtract certain figures from this amount to arrive at your adjusted gross income. 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 directly impact the amount of tax you are assessed. For a single filer, the applicable 2024 tax table dictates that $95,000 of taxable income be assessed a tax amount of $15,953. A tax credit of $1,000 would reduce the amount of taxes owed to $14,953. Non-refundable tax credits can reduce the amount of tax owed to $0 while refundable tax credits can go further and 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 to tell your employer how much federal tax is withheld from your paycheck. A new form must be filled out every time you change employers or whenever your situation changes.
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.
What Is the Difference Between Gross and Net Income?
Gross income or pay is what employees earn before taxes, benefits, and other payroll deductions like health benefits. The amount remaining after all withholdings are accounted for is called net income or net pay.
The Bottom Line
Taxpayers usually do not pay taxes on the total gross income they earn since some or all of the earnings are exempt from taxes. Tax exemptions are built into tax codification to provide benefits to certain individuals or entities. Tax exemptions reduce the amount of income on which income tax is calculated.
Article Sources
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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 Exemptions and Deferrals."
New York State Department of Taxation and Finance. "Volunteer firefighters' and ambulance workers' credit."
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. "About Form W-4, Employee's Withholding Certificate."
