For most people, the goal is the same when it comes time to file tax returns: reduce IRS taxes to save as much money as possible. Fortunately, the IRS offers a number of ways to do this in the form of tax exemptions, breaks, and credits.
Each has its own set of benefits to lower your tax liability, so understanding them and how they’re different can help you save on your taxes now and plan for how to lower taxes even more next year.
What Is A Tax Exemption?
Tax exemptions include any money you bring in that is considered non-taxable. The exemptions you qualify for will reduce your taxable income and lower your tax bill, especially if the difference places you into a lower tax bracket.
Knowing the relevant exemptions for your situation ahead of time can allow you to maximize this IRS benefit.
Tax exemptions can apply to specific types of personal income, business revenue, or even taxpayers in some cases.
Examples of IRS Tax Exemptions
The most well-known example of a tax-exemption is the status granted to 501c3 non-profit organizations. Since these entities are classified as charitable organizations, donations received are tax-free.
If you work in a job that pays per diem, you’ll be happy to know this is also considered exempt as long as it meets the standards set by the IRS. Additionally, if your income is low enough or you claim enough deductions to eliminate taxes, you would be considered a tax-exempt individual.
Other IRS tax exemptions include:
- HSA distributions used for a qualifying health expense
- Life insurance payouts (though may still be subject to estate tax)
- 401k and IRA qualified distributions if funded with after-tax contributions
- Most employee-sponsored benefits
- Gifts worth less than $23,000 in 2023 and $18,000 in 2024
What Is A Tax Break?
Simply put, a tax break is any policy or tax law that can lower taxes you owe. This can include exemptions, deductions, and credits. Since we’re already discussing exemptions and credits separately, we’ll look closer at deductions.
Tax deductions, also referred to as write-offs, are often expenses you’ve covered yourself over the year that reduce your taxable income, thereby lowering what you owe the IRS. For example, payments for medical care over a certain amount can be considered a deduction when you file your taxes.
There are also standard deductions given based on your household status. Above the line deductions are those that reduce your gross income for the year. Below the line deductions impact your adjusted gross income.
Examples of IRS Deductions
Some common deductions claimed, include:
- Student loan interest
- Charitable donations
- Mortgage interest
- IRA or 401k contributions
- Gambling losses
- Self-employment expenses
- Educator expenses
What Is A Tax Credit?
Tax credits can also save you money by directly lowering taxes rather than simply reducing the amount of money being taxed. If you owe the IRS $2,500 and you qualify for a tax credit of $500, your taxes go down dollar for dollar to $2,000.
This makes tax credits a very favorable way to reduce what you have to pay the IRS. One of the most popular examples of this is the Child Tax Credit, providing relief for the children you care for under the age of 17.
Sometimes all, or a portion, of these tax credits are refundable, meaning the balance could be sent to you even if you don’t owe taxes that year.
Examples of IRS Tax Credits
Other tax credits you might be eligible for, are:
- Child and Dependent Care Credit covering some portion of daycare expenses
- American Opportunity Act Credit or Lifetime Learning Credit for some education expenses
- Adoption Credit covering some adoption costs
- Earned Income Credit for low-income taxpayers
Making the Most of Your Tax Savings Options
Understanding the different tax breaks available ensures you don’t overpay the IRS money you shouldn’t owe. Using this knowledge throughout the year can help you budget some of your expenses and make financial decisions that help lower your taxes when it comes time to file.
There are no limits to the number of tax breaks you can qualify for, whether it’s an exemption, deduction, or credit, so maximize these tax-saving opportunities.
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