We’re going to continue our merry ride through tax season by celebrating a few of our favorite things. Those being exemptions, deductions and credits.
Boy, you know you’re getting old when those 3 words sound like a sweet canary singing on a crisp spring morning.
We all love them, and for most of us, they’re our guiding light at the end of the dark tunnel that is tax season.
But what exactly do they mean, and how do they differ? Just the names – exemptions, deductions and credits – do a pretty good job of telling us what they are. However, we all know what happens to those who assume!
In our first installment of breaking down tax jargon, we’re going to take a look at exemptions. Namely, what they are, why they’re important, and what type of exemptions are available.
What is an exemption?
Tax exemptions (and deductions) are certain things that let you blow a tax whistle and yell “Hands off!” to the IRS. That being said, there’s a key difference between the two that’s important to know.
Exemptions are distinctly personal, usually because of something significant in your life. Consider things such as religious organisations, disabled vets, or struggling families. In contrast, deductions are for purchases you’ve made throughout the year.
Breaking it down
Here’s the quick and easy run-down.
- Exemptions: More personal. Always a fixed amount set by the IRS.
- Deductions: Purchases you’ve made. Every person’s deductions will differ.
Think of it this way, you can’t deduct a child from your taxes (as much as we’d like to)! But the little munchkin might make you exempt from paying certain taxes. Your final destination remains the same, lowering your taxable income. You just took a different road to get there.
For all intents and purposes, an exemption is meant to help the person receiving it. Much as we don’t want to believe it, the IRS knows taxes are tough, especially for low income households. As such, it’s worth knowing what exemptions are out there and how they can help you.
How exemptions work (and help)
Great, now we know what exemptions are, but how does that help us?
To put it simply, the goal of exemptions is to lower your taxable income. Naturally, the lower your taxable income, the less taxes you pay.
Still confused? Don’t worry, it makes more sense when we take a look at an example.
Let’s say you make $50,000, and your taxes add up to be 50% (yikes). Naturally, that means you would owe $25,000 in taxes.
With that in mind, let’s say you own a herd of endangered yodeling goats. These gifted goats qualify you for the “Goodness Gracious Goats” tax exemption, which adds up to be $10,000. Now, keep in mind, this doesn’t mean you’ve saved $10,000, it means you don’t have to pay taxes on $10,000.
To sum it all up:
- Your income is now considered $40,000
- The taxes you owe is now $20,000
- You saved $5,000
Note: These numbers are just an example. Our tax system doesn’t work on a flat rate. We’ll cover this further down in the article.
Such as all things involving taxes, the process is a little complicated and confusing, but it works. All you really need to remember is that exemptions = pay less taxes. Who doesn’t want to pay less taxes?
Did you know? The average American paid over $8,400 in taxes for 2017. Half of that coming from the federal income tax.
Different types of exemptions
With the new 2018 tax reforms upon us, many popular exemptions have been nixed or reduced in someway. While that may be true, there’s still plenty of exemptions available that you should know about.
Did you know? The average American paid over $8,400 in taxes for 2017. Over half of that coming from the federal income tax.
Unfortunately, the $4,050 personal and dependent tax exemptions are gone. Though fear not weary tax traveler, all is not lost! You may still find some value in claiming your children as dependents.
As a matter of fact, there’s multiple tax credits you can take advantage of. Check out our article on dependents if you want to learn more about these credits!
Military veteran exemptions
Our distinguished service men and women can receive a wide range of different tax exemptions. The long list of exemptions can include, but aren’t limited to, interest paid on loans, healthcare, property mortgages, and low income. Every state is different, and the benefits may range up or down depending on the “percentage” of a person’s disability.
If you’re a vet, it’s likely you can get some sort of exemption. Be sure to check with your local state laws and see what comes up!
The American Legion has a fantastic breakdown of every benefit available to our veterans, organized by state.
This is probably the most common one you’ll hear about. Almost everyone knows that non-profits are considered tax exempt. This includes charitable foundations, religious organizations and various government foundations.
If you run a non-profit org, you probably already know about it. But it doesn’t hurt to spread the knowledge!
Clubs, leagues and other “groups”
The Illuminati doesn’t pay their taxes!
OK, all joking aside, most plushy clubs, pretentious leagues and
cults “groups” are all exempt from having to pay taxes on the donations they receive.
If you want a detailed list of every type of tax-exempt organization, you can read all about them in this IRS article.
While exemptions have taken a few hits in the 2018 tax reform, that doesn’t mean they’re all gone! Qualifying for any exemption is always a good thing, and it’s important to know what you’re able to take advantage of.
After all, if there’s one thing we know about taxes, it’s that we want to pay less of them!
Keep reading to learn about the two siblings of tax exemptions – Deductions and Credits.
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Sorry, there’s no exemption from the puppy tax!
We’re not tax specialists, nor are we trying to be! This article is purely for educational purposes and should not be treated as professional guidance. Taxes are extremely complicated and different for every individual. Always consult with a tax professional before messing with your taxes.