Closeup on notebook over desk, front focus on wooden blocks with letters making Tax Exempt text. Concept: what is a tax exemption.
Betsy Wise
By: betsy_wise
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What Is a Tax Exemption?

Who doesn’t want to reduce their tax obligations? When you do, there’s more money available to invest in your business or increase your profit margin. But first, you must get answers to the posing question, “What is a tax exemption?”

This post gives general guidelines on how to get your share of exemptions to reduce your tax bill and find out what qualifies to lower your taxable income. Always remember to consult with a tax professional and/or a financial advisor since they stay current on tax code changes and tax filing requirements.

What Is a Tax Exemption?

Taxpayers whether individuals or businesses can use a variety of exemptions to reduce the amount of tax they owe to federal, state and local governments. People, property, income, and organizations can be exempt from taxation. In some instances, applying for tax-exempt status pardons taxpayers from paying any tax or owing tax at a reduced rate.

Sometimes state and local governments help boost the economy by offering businesses tax exemptions. For example, the State of Massachusetts has offered sales tax exemptions to companies offering internet access and cable television.

Categories of Tax Exemptions That Qualify

To gain a broader understanding of “what is a tax exemption”, we’ve provided explanations below relating to these areas of tax exemption.

         What organizations are tax-exempt?

  • Charitable organizations such as humane societies, nonprofit hospitals, The Girl Scouts, religious societies, nonprofit credit unions, The United Way, and other groups are considered tax-exempt. These nonprofit organizations do not pay federal tax on earnings from assets and activities that produce a profit. That’s true as long as they don’t distribute profits and organize their group for public purposes.
  • The organizations must register with the IRS for exemption status under code 501(c) (3) by completing Form 1023. As of 2015, the IRS reported there were 1,184,547 registered nonprofit charitable organizations.

         What individuals are tax exempt?

  • In 2018, the personal tax exemption for individuals on the federal tax return merged with the standard deduction. Your filing status (single, married filing separately, head of household, married filing jointly, and qualifying widower), whether you are under or over age 65, and a gross income between $12,000 – $26,000 determines whether you file a return. Based on your filing status, when your income falls below these limits, you won’t file a return or owe tax.
  • Self-employed individuals earning less than their filing status exemption.
  • Certain children, age 19 or full-time students, don’t have to file a return. If their only income comes from interest and dividends, they are under age 19 at the end of the tax year or are under age 24 and a full-time student, their parents can elect to include the child’s income on their return.

         What type of income is tax-exempt?

  • When you own municipal bonds and earn interest, those earnings are typically tax-exempt from federal and state taxes as long as you live in the state where the bonds were issued. There’s an additional benefit from investing in municipal bonds. Most times, the money is used to build hospitals, schools, highways, and other projects that benefit the public. When the bond matures, the municipality returns the principal to you. The interest is normally paid semiannually.
  • Distributions from health savings accounts and Roth IRAs are not taxed. Certain benefits you received that are purchased with after-tax dollars include employer-sponsored supplemental disability insurance and private insurance plans.

         What type of property is tax-exempt?

  • When you sell your primary home and lived in it for two of the last five years, you are exempted from paying capital gains tax on the first $250,000 for single tax return filers and $500,000 for married couples.
  • Each state varies on what exemptions they offer. Some offer property exemptions for owning homesteads, being a senior, disabled, or military veteran, and making home renovations or installing renewable energy systems. States may use your household income to determine whether you qualify for a property exemption. It’s up to you to contact your state, county, or local authorities to see if you qualify. If you do qualify for an exemption, you are usually required to apply to receive benefits.
  • Qualifying charitable organizations that own property are usually exempted from paying property taxes.

A professional tax preparer can help you determine if you qualify for a tax exemption.

Other FAQs About Tax Exemption

  1. How is tax exemption different from tax deductions? Compared to taking tax deductions, tax exemption prohibits income from being taxed at all. On the other hand, you can take a tax deduction to reduce income in order to pay less tax. Tax exemption deals with whole amounts not being taxed; whereas tax deductions reduce a portion of your total taxable income.
  2. What’s the difference between a tax exemption and a tax credit? A tax credit is applied directly to the total tax you owe. For example, if you owe $2,000 on your tax return and take an earned income credit of $500 and a child and dependent care credit of $400, your remaining tax liability is $1,100. Contrast that to a tax exemption that enables people, organizations, property, and income from being taxed.

Keep up to Date on Other Topics About Taxes

By now, you can probably answer, “What is a tax exemption?” You may be able to apply what you learned here to make improvements to your personal and business finances.

At Camino Financial, we take our motto seriously, “No Business Left Behind.” We’re interested in seeing your business grow and provide free tools and resources to make that happen. By staying informed on trending business topics, you’re better prepared to make decisions about your business’s next stage of growth.

That’s why our goal is to provide timely information to business owners, For example, did you know that by filing proper and accurate tax returns you increase your chances of being approved for a business loan? Lenders use your information to make decisions about whether to offer you financing.



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