Tax Exemptions How Do They Work?

Taxes: we all know about them. We have to pay them, because we are legally obligated to do so. Otherwise, we might go to jail- and let’s be honest, no one wants that.  We have to contribute to the building of our roads, and paying for the public education system and more. Tax is a mandatory financial assessment or some other type of levy imposed upon a person who earns or spends money. The taxpayer is an individual or another legal entity.

Failure to pay is punishable by law. Taxes consist of direct or indirect taxes.

But what if we told you that you don’t always have to pay taxes? Well, at least we can say that there are instances wherein paying taxes is not necessary. Certain individuals and organizations are exempted from paying taxes due to specific reasons.

Let’s talk about tax exemptions: what they are and how they work. Here we’ll talk about some of the most common instances wherein tax exemptions are put in place.

What Is A Tax Exemption?

But before that, let’s define what a tax exemption is. This one is pretty straightforward and self-explanatory. Tax exemption means that the individual or organization or legal entity does not have to pay taxes—or in some cases, receive a reduction in tax rates. The reasons for getting exempted may vary depending on the situation.

Personal Tax Exemptions

In the United States, a personal exemption is an amount that a resident taxpayer is entitled to claim in the form of a tax deduction against personal income. This is done when calculating taxable income and federal income tax.

For tax years prior to 2018, individuals who are not claimed as a dependent on another taxpayer’s return, they are entitled to claim one personal tax exemption. This is a fixed amount. It generally increases each year. This exemption reduces your taxable income just like how a deduction does. The difference is that it has fewer restrictions to claiming it.

For married couples who file a joint tax return, they will each get an exemption.

Dependent Tax Exemptions

The Internal Revenue Service or IRS allows you to take additional exemptions for each dependent you claim. These exemptions are commonly used by taxpayers who have children who live with them for more than half the year. These dependents have to be under 19 years old, or under 24 if a full-time student. Dependents are given tax exemptions because they don’t provide more than half of their own financial support during the tax year.

Some of the taxpayer’s relatives may also qualify to be their dependents if they live together. The taxpayer’s parents may also be claimed as dependents.

Tax-Exempt Organizations

Perhaps the most prominent example of tax exemptions, tax-exempt organizations provide valuable services to the community and don’t operate for profit. Charities are often qualified to become tax-exempt organizations.

For an organization to receive tax-exempt status, it must satisfy all the requirements of the IRS. If an organization does receive the tax-exempt status, it means it is no longer required to pay federal income tax. However, in order to keep this status, they must maintain accurate records.

Donations you make to these organizations usually entitle you to claim a charitable contribution deduction, granted that you itemize.

Religious organizations, including temples, mosques, churches, etc, are tax-exempt organizations. Social clubs and other fraternal organizations are also included in this list of tax-exempt organizations.

Any form of organization that serves public purposes without profiting from it may be considered tax-exempt organizations.

Similarly, the UK generally exempts public charities from business rates, income tax, corporation tax, and certain other taxes.

State and Local Exemptions

Most systems exempt internal governmental units from all tax. For multi-tier jurisdictions, this exemption extends to lower tier units and across units. State and local governments are not subject to federal, state, or local income taxes in the US.

Additionally, state, county, and municipal governments provide tax exemptions to businesses to stimulate the local economy. A business may be exempt from paying local property taxes if it moves its operations to a certain area.

One example is in Massachusetts, wherein the state provides sales tax exemptions for telecommunication companies that provide cable television, Internet access, radio broadcasts, and other similar services.

Some cities and states also offer sales tax holidays where consumers can purchase goods without paying local or state taxes.

Other Examples

International duty-free shopping is also known as tax-free shopping. In tax-free shopping, the goods are permanently taken outside the jurisdiction. Paying taxes is therefore not necessary. Tax-free shopping is often found in ships, airports, and other vessels traveling between countries. Choosing how and where to get taxes for the sale of these items would get confusing, after all. So these goods are served tax-free.

Tax-free shopping is mainly available through dedicated duty-free shops, often found in airports. However, any transaction may be duty-free, given that the goods are presented to the customs when exiting the country. Sometimes, a sum equivalent to the tax is paid, but then quickly reimbursed upon exit.

This concept of tax-free shopping is more common in Europe, however. It is less frequent in the United States, with the exception of Louisiana.

There are other forms of tax exemptions used depending on where you are from. Some jurisdictions provide separate total or partial tax exemptions for educational institutions. These exemptions are often limited to certain functions or income.

As you can tell, tax exemptions come in many different forms. There are others that are not even on this list. But one thing they all have in common is that they reduce or eliminate the individual or organization’s obligation to pay tax.

Most taxpayers are entitled to an exemption on their tax return which reduces their tax bill in the same way a deduction does.

If you want to learn more about tax exemptions, and you want to find a way to apply these exemptions to your business or your company, work with Gudeman and Associates Attorneys today!

Please speak directly with one of our attorneys. None of the content on this blog or other pages constitutes legal advice.

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