Glossary of Human Resources Management and Employee Benefit Terms
An exemption is a type of tax break that either reduces or completely eliminates the obligation to pay a tax. Tax exemption is similar to a tax deduction in that it reduces the amount of taxes owed to the federal government. Certain requirements must be met to qualify for a tax exemption. Once qualified, a portion of income won’t be subject to taxation. Those who qualify to have all their income be nontaxable achieve tax-exempt status.
To have exemptions simply means you have met the necessary qualifications to reduce tax obligations. For businesses, this could mean avoiding a portion or all of federal, state, and local taxes.
Certain forms of income are nontaxable and are usually automatically exempted from your taxes. This varies by state, but nontaxable income often includes:
Eligible workers’ compensation
Eligible municipal bond interest (exempt from federal income tax)
Treasury bill interest (exempt from state and local income taxes)
Life insurance payouts
Businesses and organizations can register for exemption from federal taxes with section 501(c)(3) of the Internal Revenue Code. In order to qualify, businesses must meet the following criteria:
The business’s operation is for religious, educational, scientific, or other charitable purposes.
No net income is given to any private individual.
No attempts are made to influence government legislation, including involvement with political campaigns.
No practices of illegal activity or violation of fundamental public policy.
Business owners can apply for their businesses to be tax-exempt if they meet specific qualifications. There are also ways for individuals to become exempt.
Organizations must meet all IRS requirements in order to receive tax-exempt status. These organizations usually don’t operate for profit and provide a charitable contribution to the community, like religious organizations and charities.
Other organizations that may qualify for tax exemption include veteran’s organizations, social welfare organizations, and labor and agricultural organizations.
In order to stimulate local economic growth, state and local governments offer tax exemptions to businesses. A common example of this is when a business is exempt from paying local property taxes in return for moving their operations to a specific area.
Under the 2017 Tax Cuts and Jobs Act, personal exemptions are suspended until 2025.
Until the act was passed, if someone was not claimed as a dependent on another taxpayer’s return, they could claim one personal tax exemption. If married, they could receive an additional exemption for their spouse.
The personal exemption is a tiered exemption, so earnings that reach certain thresholds receive different amounts of exemption. These gradually decrease with higher earnings, until exemptions become unavailable altogether.
In most cases, a dependent is a person who is related to the taxpayer and is dependent on the taxpayer for their support. For children who are filed as dependents, the taxpayer is entitled to a child tax credit for each qualifying child under the age of 19, as well as children under 24 if they are students. If children are totally or permanently disabled, they can always be claimed as dependents. Exemptions cannot be filed for people who work for the family of the taxpayer, such as housekeepers or maids.
It’s common practice for employers to deduct income tax from an employee’s paycheck, but a withholding allowance reduces the amount taken out. Employees can fill out their information using the W-4 form to determine how much should be withheld from their paycheck.
Total tax exemption means being completely free from having to pay taxes. Usually, this level of tax-exempt status is reserved for charitable organizations, but certain states allow total exemption for disabled veterans.
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