Tax exemptions come in many forms, but one thing they all have in common is they either reduce or entirely eliminate your obligation to pay tax. Most taxpayers are entitled to an exemption on their tax return that reduces your tax bill in the same way a deduction does. Federal and state governments frequently exempt organizations from income tax entirely when it serves the public, such as with charities and religious organizations.
Key Takeaways
• Personal and dependent exemptions are no longer used on your federal tax return. They were suspended beginning in tax year 2018.
• A tax exemption reduces taxable income just like a deduction does, but typically has fewer restrictions to claiming it.
• Before tax year 2018, you can claim one personal tax exemption for yourself (and one for your spouse if you are married and file a joint tax return) and additional exemptions for each dependent you claim.
• Organizations that don't operate for profit and provide valuable services to the community, such as a charity, can receive tax-exempt status if they satisfy all of the necessary IRS requirements.
Tax exemptions
There are a several different types of tax exemptions that allow for certain amounts or types of income to be exempt from taxation. The most popular exemptions for individual taxpayers has traditionally been the personal and dependent exemptions.
For tax years prior to 2018, personal and dependent tax exemptions play an important role in determining your federal taxable income. However, beginning with the 2018 tax year, personal and dependent exemptions are no longer used on your federal tax return.
Personal exemptions
For tax years prior to 2018, if you are not claimed as a dependent on another taxpayer's return, then you can claim one personal tax exemption for yourself. This is a fixed amount that generally increases each year. The exemption reduces your taxable income just like a deduction does, but typically has fewer restrictions to claiming it. If you are married and file a joint tax return, both you and your spouse each get to claim an exemption.
TurboTax Tip: A business may be exempt from paying state, county, and municipal taxes if it is located in an area where governments provide tax exemptions to businesses to stimulate the local economy.
Dependent exemptions
For tax years prior to 2018, the IRS allows you to take additional exemptions for each dependent you claim. Frequently, the source of these exemptions are the children who live with you for more than half the year, are under 19 years old (or under 24 if a full-time student) and who don't provide more than half of their own financial support during the tax year. Some of your relatives can also qualify to be your dependents if they live with you and even your parents who don't. Claiming these dependents on your tax return typically allows you to claim a dependent exemption for each of them.
Tax-exempt organizations
For an organization to receive tax-exempt status, it has to satisfy all of the necessary IRS requirements. Generally, these are organizations that don't operate for profit and provide valuable services to the community such as a charity.
If an organization receives tax-exempt status it's not required to pay federal income tax, but is required to maintain accurate records to keep its status. Donations you make to these organizations usually entitle you to claim a charitable contribution deduction on your tax return if you itemize your deductions.
State and local exemptions
State, county and municipal governments also provide tax exemptions to businesses to stimulate the local economy. For example, a business may be exempt from paying local property taxes if it moves its operations to a particular geographic area. In Massachusetts, the state provides many telecommunication companies that provide cable television, Internet access and public broadcasts of radio and television an exemption from sales tax. Many cities and states also offer sales tax holidays where consumers can purchase goods without paying state or local sales taxes.
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