What Is a Tax Benefit?
The term tax benefit refers to any tax legislation that assists in reducing your tax liability. These benefits range from deductions and tax credits to exclusions and exemptions, covering areas such as family programs, education, employee benefits, and disaster relief efforts.
Some tax benefits are tied to your ability to pay taxes. For instance, the child tax credit and the earned income tax credit (EITC) reflect the costs associated with raising a family. Other benefits, like mortgage interest and charitable donation deductions, incentivize furthering social policy goals.
Key Takeaways
- Tax benefits generate savings for both individual and business taxpayers.
- Common tax benefits include deductions, credits, exclusions, and shelters.
- You can take standard or itemized deductions plus any valuable above-the-line deductions.
- Eligibility for tax benefits requires meeting specific criteria, such as income limits, filing status, and dependent status.
- Stay informed about tax benefits to make sure you don’t miss out on potential savings.
Understanding Tax Benefits
Tax benefits help individuals and corporations lower their tax bills considerably. These incentives form an integral part of federal, state, and local tax regulations.
Deductions, credits, exemptions, and exclusions reduce the total amount owed annually to federal and state governments. On the other hand, tax shelters, through specific investments, offer legal devices that provide favorable tax treatment. Common examples include municipal bonds and employer-sponsored 401(k) plans.
Eligibility
Eligibility for tax benefits varies. For example, to qualify for head of household status, you must be unmarried, have a qualifying dependent who lives with you, and cover more than half of the household expenses for the year.
Tax benefits for educational expenses are available only if you spend on tuition and related costs during the tax year. Keeping abreast of potential tax benefits you qualify for can make a significant difference. Consulting a tax professional, such as an accountant, can help maximize your tax savings.
Types of Tax Benefits
Tax benefits come in various forms. Here are some of the most common ones:
Tax Deductions
A tax deduction reduces your taxable income, giving you lower taxable income to report on your annual return. You can either take the standard deduction or itemize your deductions:
- Standard Deduction: A fixed amount that reduces taxable income. For the 2023 tax year, the standard deduction is $13,850 for single filers and married taxpayers filing separately, $20,800 for heads of household, and $27,700 for married couples filing jointly and surviving spouses. These figures will increase in 2024 to $14,600, $21,900, and $29,200, respectively.
- Itemized Deductions: Qualified expenses listed on Schedule A of your tax return, decreasing taxable income by summing up qualified expenses and subtracting them from your adjusted gross income (AGI).
If itemizing your expenses yield more deductions than the standard deduction, it makes sense to itemize. For instance, if a single taxpayer’s itemized expenses are $15,000, itemizing is beneficial over taking the $13,850 standard deduction.
Even if you don’t itemize, you can still claim certain above-the-line deductions along with the standard deduction. Such deductions, like student loan interest or traditional IRA contributions, lower your taxable income and possibly your tax bracket.
Tax Credits
Tax credits work by deducting a specific amount from your tax bill, unlike deductions that reduce taxable income. For example, a $3,000 tax bill with a $1,000 tax credit would reduce your liability to $2,000.
Refundable Tax Credit
A refundable tax credit results in a refund if the credit exceeds your tax bill. For example, a $3,400 tax credit on a $3,000 tax bill results in a $400 refund.
Non-Refundable Tax Credit
A non-refundable tax credit reduces the tax bill to zero but offers no refund for exceeding the bill. For instance, a $3,400 non-refundable tax credit on a $3,000 tax bill eliminates liability but forfeits the remaining $400.
Exemptions and Exclusions
Though the personal tax exemption was suspended under the TCJA from 2018 through 2025, some exclusions still apply, such as employer-based health insurance payment programs. These exclusions don’t appear on your tax return and lower your taxable income.
Tax Shelters
Tax shelters provide various tax advantages, lowering your liability if you meet defined terms. Popular examples include 401(k) plans and legal entities located within tax haven regions like the Bahamas or Cayman Islands.
However, illicit tax shelters are treated as fraudulent activities by the IRS and can result in penalties, prosecutions, and imprisonment.
Comparing Tax Credits and Tax Deductions
Tax credits and deductions decrease the tax you owe, but function differently. Tax credits cut your tax liability directly, while tax deductions lower your taxable income.
For instance, a $1,000 tax credit reduces a $1,500 tax bill to $500, whereas a $1,000 tax deduction lowers taxable income by $1,000, resulting in savings that depend on your tax bracket percentage.
Estate Tax Exemption for 2023 and Beyond
For 2023, the estate tax exemption stands at $12.92 million, increasing to $13.61 million in 2024.
Earned Income Tax Credit for 2023
EITC is a refundable tax credit for low- and moderate-income households. The 2023 EITC ranges depending on dependents and income, with variations set for 2024.
Conclusion
Understanding your tax benefits can significantly impact your financial well-being. Familiarizing yourself with pertinent tax deductions, credits, exclusions, and shelters can differentiate between a refund and an unwelcome tax bill. For additional guidance, consider consulting a tax professional to secure optimum savings.
Related Terms: Tax Liability, Child Tax Credit, Earned Income Tax Credit, Tax Shelters.
References
- Internal Revenue Service. “Credits & Deductions”.
- Internal Revenue Service. “401(k) Plan Overview”.
- Internal Revenue Service. “Tax Exempt Bonds”.
- Internal Revenue Service. “Publication 501, Dependents, Standard Deduction, and Filing Information”.
- Internal Revenue Service. “Education Credits–AOTC and LLC”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2024.”
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2023”.
- Internal Revenue Service. “About Schedule A (Form 1040), Itemized Deductions”.
- Internal Revenue Service. “Child Tax Credit”.
- Internal Revenue Service. “Earned Income Tax Credit (EITC)”.
- Internal Revenue Service. “The Premium Tax Credit - The Basics”.
- Internal Revenue Service. “Credits and Deductions for Individuals”.
- Internal Revenue Service. “Personal Exemptions”, Page 5-1.
- Internal Revenue Service. “What Is Taxable and Nontaxable Income?”
- Internal Revenue Service. “Small Business Health Care Tax Credit Questions and Answers: How to Claim the Credit”.
- Internal Revenue Service. “Frequently Asked Questions on Gift Taxes”.
- Congressional Research Service. “Tax Havens: International Tax Avoidance and Evasion”, Page 4.
- Internal Revenue Service. “Regulations on Abusive Tax Shelters and Transactions”.
- U.S. Securities and Exchange Commission. “What are Municipal Bonds”.
- Internal Revenue Service. “Rev. Proc. 2023-34”, Page 9.
- Internal Revenue Service. “Earned Income and Earned Income Tax Credit (EITC) Tables”.
