Key Takeaways
- A tax exemption can reduce or eliminate the amount owed in certain types of taxes, such as income tax, property tax, or sales tax.
- Many different types of tax exemptions exist, some of which apply to individuals and some to organizations.
- To receive the benefits of a tax exemption, you’re often required to apply for it. However, in some cases, a tax exemption may automatically kick in.
How Tax Exemptions Work
A tax exemption works by either reducing or waiving tax liability, and the details depend on factors such as who’s receiving the tax exemption and where it’s being applied.A tax exemption enables individuals or organizations to avoid paying some or all taxes in situations that would generally incur a tax liability if the exemption did not exist.
In many cases, receiving a tax exemption requires an individual or organization to apply for that status. For example, you may have to initially apply to receive a property tax exemption based on your age or veteran status. That exemption might continue automatically for as long as you live in that home, depending on local laws, or you may need to reapply periodically.
Note
In some situations, a tax exemption could apply automatically. During a tax holiday, for instance, some types of purchases might automatically be exempt from sales taxes. That means you can buy items as you normally would and simply avoid paying sales tax on their value.
Organizations also typically have to apply for tax exemption. To receive tax-exempt status from the IRS, for example, a nonprofit has to complete an application. They may also have to apply for state or local tax exemptions.
Examples of Tax Exemptions
For example, some nonprofits apply for federal tax exemptions with the IRS so that they don’t have to pay federal income tax. Tax exemptions can also apply at the state or local level, such as when a qualifying religious organization is exempt from paying property taxes.
Individuals can qualify for exemptions from different types of taxes depending on their circ*mstances. Foreign students with income from a part-time job on campus, for example, may be eligible for an exemption from paying Social Security or Medicare taxes. Diplomats from other countries may be exempt from sales tax when they make purchases in the U.S.
And perhaps most commonly, many individuals qualify for property tax exemptions through their state, county, or municipality. However, these exemptions often reduce rather than eliminate the amount of property tax owed. For example, the Homestead Exemption (or Homeowners’ Exemption) often allows homeowners to reduce the assessed value of their primary residence, meaning they’re taxed on a lower amount, though the specific rules vary based on local tax regulations.
What Tax Exemptions Mean for Individuals
Understanding tax exemptions can help individuals save money by reducing how much tax they may owe. It’s often worth looking into whether any tax exemptions apply to your situation for any type of tax you may owe, whether that’s property taxes, payroll taxes, or other types of taxes.
Note
A tax professional can help you properly claim tax exemptions so you can legally reduce what you owe in taxes.
Keep in mind that tax exemptions can change over time. Prior to 2018, for example, many people were eligible to claim what was known as the personal exemption on their federal income taxes, which reduced their taxable income. The Tax Cuts and Jobs Act (TCJA) removed the personal exemption, though it’s possible that it will return if the TCJA expires as scheduled after 2025.
Also, if you’re considering starting a business, you may want to look into potential tax exemptions to see if you could save money. Some types of environmentally friendly businesses, for example, may be eligible for tax credits and tax exemptions that could incentivize you to start a company in a certain area. New York state, for instance, allows for a sales and use tax exemption for selling and installing commercial solar energy systems. That alone might not be enough of a reason to start a business in the state, but it’s a factor worth considering if you were already leaning toward that location.
Frequently Asked Questions (FAQs)
How do I qualify for tax exemptions?
There are a number of ways to qualify for tax exemptions depending on your situation. For example, there are certain exemptions for real estate, charities, sales tax and interest. You must apply for the exemption if you think you qualify.
What is the meaning of non-exempt on a tax form?
This often relates to employment, in which a non-exempt employee is paid hourly rather than salaried. This impacts taxes because overtime pay would be taxed like all other income.
