The term tax break refers to a benefit the government offers that reduces your total tax liability. Tax breaks are possible through specific tax laws and come in the form of credits, deductions, and exemptions. These measures may also exclude certain types of income from your state or federal tax return, providing significant financial relief for taxpayers.
Tax breaks can notably impact various groups. For instance, churches and religious organizations are generally exempt from income and property taxes. People affected by natural disasters also receive tax benefits, including filing extensions, penalty waivers, and deductions for casualty and theft losses.
Key Takeaways
- Tax credits and deductions lower your total tax liability, thanks to established tax laws aimed at economic strengthening and promoting policy goals.
- Specific tax breaks are designed to encourage economic activities, like pursuing secondary education.
- A tax credit offsets your tax liability dollar-for-dollar, potentially resulting in a refund if it’s a refundable credit, whereas a tax deduction lowers the income subject to tax.
How Tax Breaks Work
Government-provided tax breaks significantly reduce tax liabilities for individual and corporate taxpayers through credits, deductions, exemptions, and exclusions.
Some tax breaks, like life insurance proceeds, are automatic—these are excluded from taxable income without needing action. However, most tax benefits, like credits or deductions, must be claimed on your income tax return, meeting specific eligibility requirements.
Tax breaks also play a crucial role in stimulating the economy. By increasing disposable income for individuals and investment capabilities for businesses, they promote behaviors beneficial to society, such as adopting fuel-efficient vehicles.
Federal tax law regulations detail how tax breaks function, the qualifications, and their duration. The U.S. Congress and the president are responsible for amending these laws, as exemplified by the Tax Cuts and Jobs Act of 2017, which brought significant changes to the U.S. tax system.
Types of Tax Breaks
Tax Credits
Tax credits reduce your tax liability on a dollar-for-dollar basis, more impactful than a deduction, which lowers taxable income. For example, if you owe $3,000 in taxes and qualify for a $1,100 tax credit, your liability drops to $1,900.
Corporations also benefit from tax credits through credits for various functions, fostering economic stability and growth. There are both general credits and those specific to industries like agriculture and energy.
Tax Deductions
Tax deductions, such as the standard deduction, reduce your taxable income, thereby lowering your tax bill. For example, a $1,000 deduction in a 22% tax bracket saves you $220 ($1,000 × 22%). Taxpayers can choose the standard deduction or itemize their deductions using Schedule A of Form 1040 or 1040-SR.
Standard Deductions for 2022 and 2023
| Filing Status | 2022 Standard Deduction | 2023 Standard Deduction |
|---|---|---|
| Single | $12,950 | $13,850 |
| Married Filing Separately | $12,950 | $13,850 |
| Heads of Household | $19,400 | $20,800 |
| Married Filing Jointly | $25,900 | $27,700 |
| Surviving Spouses | $25,900 | $27,700 |
Itemizable deductions include mortgage interest, significant medical expenses, state and local taxes, charitable contributions, and casualty losses, among others.
Tax Exclusions
A tax exclusion allows certain income to be exempt from taxation. Examples include child support payments, life insurance proceeds, and income from municipal bonds. Income from employer-paid health insurance premiums and portions of premiums you pay are also typically excluded from taxable income.
Real estate gains up to $250,000 ($500,000 for joint filers) from the sale of a primary residence can also qualify for exclusion if specific conditions are met. Additionally, the foreign-earned income exclusion provides tax relief for income earned abroad.
Comparing Tax Credits and Tax Deductions
Tax credits lower the amount of tax owed directly, while tax deductions reduce taxable income, resulting in lesser tax discounts. For taxpayers at a 22% tax bracket, a $1,000 deduction translates into $220 savings, whereas a $1,000 credit saves the full $1,000 on the tax bill.
Are Tax Credits Better Than Deductions?
Tax credits often provide more significant benefits compared to deductions, especially refundable credits that can result in a refund if the taxpayer’s liability falls below $0. While deductions reduce a taxpayer’s income sight, credits can substantially lower the tax burden directly.
Annual Gift Exclusion
For 2022 and 2023, the annual exclusion for gifts is $16,000 and $17,000, respectively. This allows individuals to give money tax-free up to those amounts to as many people as desired without affecting lifetime gift and estate tax exemptions.
Who Qualifies for Tax Breaks?
Tax breaks often favor individuals with lower incomes as they phase out for higher income levels. Specific credits and deductions promote economic activities such as retirement savings, providing advantage to those who meet set qualifications.
The Bottom Line
Reducing tax liability is a central goal for many, with individuals, corporations, and nonprofits leveraging tax breaks. Tax breaks aid in excluding income from being taxable, allowing deductions, and giving credits to minimize taxes owed. Pursuing available tax breaks is wise to efficiently manage tax exposure.
Related Terms: tax credits, tax deductions, tax exclusions, tax liability, tax planning.
References
- Internal Revenue Service. “Tax Information for Churches and Religious Organizations”.
- Internal Revenue Service. “Credits and Deductions for Individuals”.
- Internal Revenue Service. “Publication 525, Taxable and Nontaxable Income”, Pages 22-23, 30.
- Internal Revenue Service. “Tax Reform Provisions That Affect Individuals”.
- Internal Revenue Service. “Publication 5307, Tax Reform Basics for Individuals and Families”.
- Internal Revenue Service. “Churches, Integrated Auxiliaries, and Conventions or Associations of Churches”.
- Internal Revenue Service. “Exemption Requirements - 501(c)(3) Organizations”.
- Internal Revenue Service. “Business Tax Credits”.
- Internal Revenue Service. “Credits and Deductions for Individuals”.
- Internal Revenue Service. “Rev. Proc. 2021-45”, Page 14.
- Internal Revenue Service. “Rev. Proc. 2022-45”.
- Internal Revenue Service. “Publication 936 (2021), Home Mortgage Interest Deduction”.
- Internal Revenue Service. “Topic No. 502 Medical and Dental Expenses”.
- Internal Revenue Service. “Employee Benefits”.
- Internal Revenue Service. “Topic No. 701 Sale of Your Home”.
- Internal Revenue Service. “Foreign Earned Income Exclusion”.
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2023.”
