How Do Tax Exemptions Work in Your Favor?

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How Do Tax Exemptions Work in Your Favor?

A tax exemption has no disadvantages. Under tax law, the phrase has a particular meaning: Federal, state, and municipal governments establish them to offer a benefit to certain persons, corporations, or other organizations in unique circumstances. Those who are eligible for them save money on taxes.

A tax exemption, as most taxpayers understand it, is the privilege to deduct a percentage of one’s income or a certain amount of money from one’s total income. Because such income is disregarded, the taxes owing are decreased.

Key Takeaways

  • The federal standard deduction is the most well-known tax exemption.
  • State and local exemptions are less well-known.
  • They, like any exception, are intended to encourage or protect a certain group of individuals.

In reality, an exemption may shield some income or take the shape of a decrease in the value of taxable property. Alternatively, it might imply total exemption from income taxes for organizations that promote the public good.

Here’s a look at the many types of exemptions, beginning with the one that every taxpayer is entitled to.

The Standard Deduction

There used to be a personal exemption that persons who did not itemize their tax deduction could claim in addition to the standard deduction. Instead, the 2017 Tax Cuts and Jobs Act included a single large standard deduction (TCJA).

Individuals and families are entitled to this deduction under federal tax law just for being taxpayers who submit returns.

The standard deduction for single taxpayers and married couples filing separately in 2021 is $12,550 ($12,950 in 2022). It is $25,100 for married couples filing jointly ($25,900 for 2022), and $18,800 for heads of households ($19,400 for 2022).

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Property Tax Exemptions

Property owners may be granted exemptions from real estate taxes payable on their property by state and municipal governments. The exemptions are intended to reward or protect specific types of homeowners by lowering the amount of property taxes paid. Here are some examples of common property tax exemptions:

  • Homestead. This exemption is available to those who possess a primary residence in a state or municipality that encourages it. In Florida, for example, homeowners who are Florida citizens are eligible for a homestead exemption of up to $50,000. Those who own vacation properties in the state are not eligible for the exemption.
  • Disability and old age Some municipalities provide property tax reductions to seniors and the handicapped. Age alone may not be enough. A demonstration of financial necessity may be necessary as well. Even the word “senior” varies by region. Washington State provides a senior exemption beginning at the age of 61, as well as exemptions for veterans and disabled retirees.
  • Volunteer work. Some municipalities provide property tax exemptions to military veterans, while some only apply to handicapped veterans. The exemption may be extended to the survivor’s spouse or parents. Some municipalities provide exemptions for volunteers. Volunteer firemen and ambulance personnel, for example, are excluded in New York.

These are just a few examples of exemptions that may be granted in some states and localities. Others are available for persons who are repairing ancient buildings, establishing sustainable energy systems, or who have lost a spouse.

Veterans, elderly citizens, and individuals with disabilities may benefit from state and municipal tax exemptions.

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Some exemptions only apply to a part of the property taxes. The New York State School Tax Relief (STAR) exemption, for example, which is no longer accessible to new applicants, solely applies to the school tax part of the bill.

Double Dipping

Using one exemption does not prevent a taxpayer from using others. For example, a Miami homeowner who claims the homestead exemption may be eligible for additional exemptions if they are a handicapped veteran.

Exemptions from property taxes are not automatic. Homeowners must apply for them and provide proof of eligibility.

Tax-Exempt Organizations

Charities, fraternities, labor groups, trade associations, churches, and other organizations exist for a reason other than profit.

The legislation allows these organizations to function without having to pay income taxes on the money they receive. (They, like for-profit enterprises, pay employment taxes on their employees.)

Tax-exempt status implies that the monies they raise are not recognized as taxable income, but rather as non-taxable donations.

Contributors Get Deductions, Too

Contributions to certain, but not all, tax-exempt organizations may be deducted by taxpayers. Payments to the Red Cross (a 501(c)(3) charity, for example, are tax deductible, but donations to a chamber of business (a 501(c)(6) organization are not.

These organizations apply to the IRS for tax-exempt status. Those who gain IRS permission are subject to special reporting requirements.

If a tax-exempt entity earns money from a company that is unrelated to its exempt purpose, it must pay taxes on that money. For example, if a nonprofit institution has a public coffee shop, the profits from it may be taxed. If the coffee shop is only open to college students, it is not taxed.

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