What is an exemption?

March 24, 2021 : H&R Block

The term “exemptions” can apply to many facets of taxes. There are home, healthcare, and real estate exemptions, to name a few applications of this term.

In this post, we’ll outline what is a tax exemption, and how to apply the knowledge of this definition to your specific tax situation.

Read on to better understand what a tax exemption is, what is tax exempt, and other state tax exemptions.

What is a tax exemption?

Wondering the answer to “what is a tax exemption?” An exemption is a tax deduction that lowers the amount of income that would otherwise be taxed. Prior to the Tax Cuts and Jobs Act, the IRS offered two tax exemptions:

1 – Personal exemptions: The amount a taxpayer is entitled to claim as a tax deduction against personal income. Personal exemptions were an input to calculate the amount owed in federal income taxes. All taxpayers could claim a personal exemption. For married taxpayers filing separate returns, an exemption could only be claimed for a spouse if that spouse:

  • Had no gross income
  • Wasn’t filing a tax return
  • Wasn’t the dependent of another taxpayer

2 – Dependent exemptions: Taxpayers could also claim a tax exemption for dependents pre-tax reform. A dependent qualified as either a child or a relative who met a series of tests. (See IRS Publication 501, Exemptions, Standard Deduction and Filing Information for more information.)

Tax reform brought changes and you now can’t take tax exemptions. These changes are enforced until 2025.

Tax exemption vs. standard deduction trade-off post tax reform

While personal and dependent tax exemptions went away with tax reform, the standard deduction amount when filing federal taxes nearly doubled. For couples, the amount went from $12,700 to $24,000. For an individual taxpayer, the amount went from $6,350 to $12,000.

Other tax exemption definition

The term “tax exemptions” has multiple meanings. In fact, there are a few more exemption definition that applies to taxes as well:

1 – Employee withholding exemptions

All employers of W-2 employees withhold income tax from their employees’ pay. This payment is remitted through their paychecks to the IRS. If an employee has zero tax liability, they can request an exemption from withholding. This means their employer doesn’t take out any federal income tax withholdings from their paycheck and would withhold only Social Security and Medicare contributions.

Tax exemption form for employee exemptions

If an employee is tax exempt and has no withholdings, what tax exemption form would they use? The answer: Form W-4.

2 – State tax exemptions

City, county, and state governments offer tax exemptions to businesses to fuel the local economy. There are multiple state tax exemptions for paying property taxes, for example, if the business meets certain conditions. Some states also have lowered tax rates for certain types of industries. To find if your state tax exempt laws, visit your area’s department of revenue/taxation’s website. You can also view more information about state taxes.

3- Tax exemptions for non-profit organizations

To make matters more complicated, many non-profit organizations are exempt from some taxes.

Generally, any organization that doesn’t operate for profit and offers valuable community services can qualify for non-profit tax exemptions. In fact, they are exempt from most federal income tax and some state tax (property or sales). Additionally, some charitable contributors can take tax deductions for donations to qualifying non-profit organizations. 

Tax designations for non-profits are 501(c)(1-28). The most common is 501(c)(3).

Qualified non-profits have a tax exemption number. You can apply for one or search for one on IRS.gov. In the search tab, you can look up organizations by name, state, or zip code.

So, what is tax exempt?

In this resource, you’ve learned individual taxpayers, employees, businesses, and other non-profit entities can be tax exempt.

Frankly, there are a lot of rules when it comes to taxes, so let H&R Block guide you. With many ways to file, we can work with your unique tax situation.

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