sparkle-illustration

Missed Tax Day? File as soon as possible to limit penalties. Try our fast, hassle-free tax filing. It's just $50.

Missed Tax Day? Try our fast, hassle-free tax filing. It's just $50.

Learn more

What Does It Mean to Be Tax-Exempt? Definition, How Tax Exemptions Work

Tax exemptions, exempt workers and tax-exempt status mean different things. They can also affect your tax bill.

Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. However, this does not influence our evaluations. Our opinions are our own. Here is a list of our partners and here's how we make money.

Updated · 1 min read
Profile photo of Tina Orem
Written by Tina Orem
Assistant Assigning Editor
Profile photo of Lei Han
Reviewed by Lei Han
Professor of accounting
Profile photo of Chris Hutchison
Edited by Chris Hutchison
Lead Assigning Editor
Fact Checked

Being tax-exempt or having a tax exemption seems like a way to lower your tax bill, but it can get you in trouble if you don't understand the difference between tax exemptions, exempt workers and tax-exempt status. Here’s how those terms tend to appear in the wild and how you can make them work for you.

What does tax-exempt mean?

Being tax-exempt means that some or all of a person's or business's income is free from federal, state or local tax. Tax-exempt organizations are typically charities or religious organizations recognized by the IRS

Internal Revenue Service. Exempt Organization Types. Accessed Mar 26, 2024.
. They’re exempt from federal taxation (that is, they have tax-exempt status), and donations to them are typically tax-deductible.

What qualifies you to be a tax-exempt individual?

For individuals, this term often has three meanings.

1. Are you exempt from withholding tax?

You may be able to elect to have federal income tax withheld from your paychecks by changing your W-4 at work. Social Security and Medicare taxes will still come out of your check, though.

Typically, you can be exempt from withholding tax only if two things are true:

2. Did you receive income that isn't taxable?

This is rare, because the Internal Revenue Code defines taxable income as gross income minus deductions. And gross income, federal law says, “means all income from whatever source derived

Legal Information Institute. 26 U.S. Code § 61 - Gross Income Defined. Accessed Mar 26, 2024.
.”

That’s a lot of territory, covering earned income such as wages and unearned income from investments and other sources. However, there are some types of income that typically aren't subject to tax.

3. Are you exempt from minimum wage and overtime rules?

The Fair Labor Standards Act requires that most workers get paid at least minimum wage and overtime. However, some people in executive, administrative, professional and outside sales jobs are exempt from those rules.

The Labor Department uses a few tests to determine whether an employee is exempt from the minimum wage and overtime rules, which generally have to do with pay and job duties. You can visit the department's website for more information.

What is a tax exemption?

A tax exemption is the right to exclude certain income or activities from taxation. Up until 2018, taxpayers were able to exclude up to $4,050 for each eligible individual off their income by claiming personal exemptions. Personal exemptions no longer exist

.

The difference between tax exemptions, tax deductions and tax credits

Tax exemptions aren’t the same as tax deductions or tax credits.

  • Tax exemptions whittle down what counts as income in the first place; that is, exemptions usually come right off the top.

  • Tax deductions generally are expenses you’ve incurred that whittle down the amount of your income that's subject to tax.

  • Tax credits are dollar-for-dollar reductions in your tax bill.

Get more smart money moves – straight to your inbox
Sign up and we’ll send you Nerdy articles about the money topics that matter most to you along with other ways to help you get more from your money.