Exemption

Understanding taxes and the different terms that impact taxes is always beneficial. Gaining clarity on terms and topics can prevent confusion and errors in judgment. 

What is the definition of an exemption? 

An exemption refers to any kind of investment, expense, or income that either reduces or eliminates the amount of tax obligation. Exemptions are allowed by law to be non-taxable and reduce the amount of income subject to tax. As a consequence, reducing the taxable income results in reduced taxes owed to the federal government. 

There are specific requirements set by the Internal Revenue Service (IRS) for tax exemption qualifications. In some cases, an exemption can eliminate tax obligations. This is called tax-exempt status. 

What is the significance of exemptions? 

If you have exemptions, this means that you are qualified to reduce your tax obligations. Remember that exemptions lower your taxable income, thereby also reducing your taxes due. For businesses, having exemptions can lead to decreasing a portion of or avoiding all federal, state, and local taxes. 

Is a Tax Exemption the same as a Tax Deduction? 

Both tax exemptions and tax deductions reduce tax liability. In this light, it is easy to confuse one with the other. Though they are related, a tax exemption is different from a tax deduction. They are not the same. 

A tax exemption is considered income that is non-taxable in the first place. Tax exemptions are taken away first before arriving at the gross income. On the other hand, tax deductions are originally taxable expenses. However, by satisfying certain conditions, tax deductions can be subtracted from the taxpayer’s gross income.

Is a tax exemption the same as a tax credit? 

No, they are not the same. As we have already mentioned above, tax exemptions are non-taxable, to begin with. It is not included in the gross income which is the income that is subject to tax. A tax credit is applied to reduce the amount of tax owed to the federal government. It does not have anything to do with the amount of taxable income. 

What are examples of exemptions? 

There are kinds of income that are considered non-taxable. Meaning, they are exempted from tax liability. Here are some examples of exemptions: 

• Child support
• Alimony
• Inheritances
• Eligible workers’ compensation
• Eligible municipal bond interest (exempt from federal income tax)
• Treasury bill interest (exempt from state and local income taxes)
• Disability benefits
• Life insurance payouts

What are examples of tax-exempt organizations?

Tax-exempt organizations are commonly those that operate for the good of the public. Aside from religious and charitable organizations, other organizations can qualify as tax exempt. Examples are veterans’ organizations, labor and agricultural organizations, and social welfare organizations. 

How can an organization have a tax-exempt status? 

For a business to be recognized as tax-exempt, it must apply for recognition of exemption with the Internal Revenue Service (IRS). Most organizations use Form 1023. This is the “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code”. To be recognized as tax-exempt, the organization must meet specific criteria such as:

• There should be no net income given to private individuals. 
• The purpose of the organization is for religious, scientific, educational, or other charitable endeavors. 
• There should be no involvement in political campaigns or any step to influence government legislation. 
• There should be no illegal activities or violations of public policy. 

The IRS has a fee for exemptions applications. Organizations can submit their accomplished forms electronically. All applications are processed in the order that the IRS receives them. However, an organization can request for an application to be expedited. The reason must be valid and compelling, subject to the approval of the IRS. 

What are personal exemptions? 

Personal exemptions are exemptions that were allowed by the Internal Revenue Service (IRS) until the 2017 filing year. However, the 2017 Tax Cuts and Jobs Act removed personal exemptions. The act suspended personal exemptions until 2025. Before this act, if a person is not declared as dependent on another person’s tax return, they could claim one personal tax exemption. 

What are dependent exemptions?

A taxpayer’s dependents are people who rely on the taxpayer for support. Dependents are commonly children of taxpayers who are minors. However, taxpayers are allowed to claim other dependents. They can be relatives of the taxpayer who is completely dependent on the taxpayer. 

The IRS determines who can be considered a dependent. People who work for a family (housekeepers, maids, gardeners, etc.) are not considered dependents.