What does tax-exempt mean?

Tax exemptions might help people, businesses and organizations lower their tax bills. By understanding what a tax exemption is, you might find ways to decrease your tax burden when filing taxes.

Here’s what it means to be tax-exempt.

Key takeaways

• The term tax-exempt describes any income or transaction that’s free from being taxed at the federal, state and local level.
• Individuals, businesses and organizations with a tax-exempt status have a limit on the amount of income or gifts they can be taxed on.
• A tax exemption is different from a tax deduction or tax credit.

Tax exemptions may reduce or eliminate a taxpayer’s obligation to pay taxes. Tax-exempt income typically won’t be taxed at the federal, state or local level.

Tax-exempt can also refer to a business, organization or individual that has tax-exempt status. To have tax-exempt status means having a limit on what’s considered taxable income. For example, religious or charitable organizations are often considered tax-exempt.

Tax exemptions aren’t the same as tax deductions or tax credits, though the terms are sometimes confused. Here are two key differences:

• Tax deduction: A tax deduction reduces the amount of income a person reports, based on certain expenses. Deductions can be either itemized or taken as a standard deduction. Common tax deductions include charitable donations, student loan interest, mortgage interest and unreimbursed medical expenses.
• Tax credit: A tax credit can reduce the amount of taxes a taxpayer owes or increase their tax refund. These credits can be refundable, nonrefundable or partially refundable. Common tax credits include the Earned Income Tax Credit and retirement savings contributions.

Take a look at a few tax-exemption examples:

The Tax Cuts and Jobs Act of 2017 suspended personal and dependent exemptions in favor of raising the standard deduction to $13,850 for single and married taxpayers filing separately or $27,700 for married taxpayers filing jointly in 2023. But remember, deductions and exemptions aren’t the same thing.

However, there are other tax exemptions, including:

• Income from child support, foster care or employer-assisted adoption
• Income from certain capital gains, like selling a home
• Interest earned on municipal bonds
• Government disaster relief funds
• Roth IRA withdrawals
• Inheritances, gifts or accelerated death benefits
• Scholarships

Taxpayers who had no tax liability for the previous year—and expect to have no liability again for the current year—may be able to use an IRS Form W-4 to ask their employer not to deduct federal income tax from their wages. This means the employee won’t make any federal income tax payments throughout the year and likely won’t qualify for a tax refund.

But claiming this exemption without actually being eligible can come with consequences—like a hefty tax bill and even penalties.

Some state and local governments offer exemptions to businesses. This may include exemptions on property taxes for businesses operating within a certain geographic area or exemptions for providing public services.

To qualify for tax exemptions, organizations must meet certain IRS requirements—and then keep accurate records to maintain tax-exempt status. Examples of tax-exempt organizations include:

• Charities
• Churches and religious groups
• Private foundations
• Political organizations

Tax exemptions can help reduce or eliminate taxable income for qualifying individuals, businesses or organizations.

There’s plenty to learn when it comes to taxes. If you’re interested in reading more, you could start with some basics about income and age requirements for tax filing. If you have additional questions regarding your situation, consider consulting a tax professional.