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Exemptions: What They Are and How They Affect Your Taxes

Tax exemptions, exempt workers and tax-exempt status mean different things. They can also mean different things for your tax bill.
Updated May 14, 2018
Income Taxes, Personal Taxes, Taxes
What Are Tax Exemptions and How Do They Work?
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A tax exemption is one way to lower your tax bill, but it’s not the only exemption that affects your taxes. Knowing the difference among tax exemptions, exempt workers and tax-exempt status will help you optimize your tax situation. Here’s how those terms tend to appear in the wild and how you can make “exempt” work for you.

Confusing term No. 1: Tax exemption

Tax exemptions aren’t the same as tax deductions, but they have the same end game: They cut your tax bill.

  • Tax deductions generally are expenses you’ve incurred that whittle down the amount of your income that’s subject to tax.
  • Tax exemptions whittle down what counts as income in the first place; that is, exemptions come right off the top.

There used to be two kinds of income tax exemptions — personal exemptions for you and your spouse, and dependency exemptions typically for your children or other people you support — but these went away with the new tax rules that took effect in 2018.

In 2017, the personal and dependency exemption was $4,050. If you were single, that meant you got to lop $4,050 off your income by claiming a personal exemption for yourself. If you were filing a joint return, you and your spouse each got to take a personal exemption. There were special rules if you’re married but file separately. You also got an exemption for each of your dependents.

But again, these exemptions have gone away.

Confusing term No. 2: Exempt worker

This phrase can have two meanings.

1. You’re exempt from withholding

In this situation, you’re electing not to have federal income tax withheld from your paychecks. Social Security and Medicare taxes will still come out of your check, though.

Knowing the difference among tax exemptions, exempt workers and tax-exempt status will help you optimize your tax situation.

Typically, you become exempt from withholding only if two things are true:

2. You’re 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. They generally have to do with pay and job duties. Learn more on the department’s website.

Confusing term No. 3: Tax-exempt status

This term typically refers to charities that are recognized by the IRS. They’re exempt from federal taxation, and donations made to them are typically tax-deductible.

You can cut your tax bill by making donations to tax-exempt organizations, but be sure that the organization is indeed tax-exempt. You can do that by visiting the IRS’s Exempt Organizations Select Check tool.

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