What Is an Exemption?
Let me explain what an exemption is in simple terms: it's something that reduces the amount of your income that's subject to income tax. The IRS allows various types of exemptions, and in the past, the most common were personal and dependent ones. However, the 2017 Tax Cuts and Jobs Act changed things by eliminating the personal exemption until the end of 2025. Dependent exemptions and other varieties still exist, so you can continue to benefit from them in your tax planning.
How an Exemption Works
Before the Tax Cuts and Jobs Act, you could claim a personal exemption alongside the standard deduction if you didn't itemize. Now, that's been replaced by a single, higher standard deduction introduced by the TCJA. Exemptions used to significantly impact your annual taxes by lowering taxable income, and they still can today, depending on your situation. You need to understand these mechanics to optimize your tax return.
Personal Exemptions
The personal exemption was repealed in the 2017 reforms, but it's been offset by higher standard deductions for individuals and couples. For tax year 2022, if you're filing as single, the standard deduction is $12,950; for heads of household, it's $19,400; and for married filing jointly, it's $25,900. In 2023, these rise to $13,850 for singles, $20,800 for heads of household, and $27,700 for married filing jointly. These were part of broader changes in the Tax Cuts and Jobs Act.
Up through the 2017 tax year, you could claim $4,050 per taxpayer, spouse, and dependent child. For instance, with three exemptions, you'd deduct $12,150 from taxable income, though high earners faced phase-outs. You could only claim this if not listed as a dependent on another's return—unlike deductions, which had different rules. A college student claimed as a dependent by parents, for example, couldn't take the personal exemption but could still use the standard deduction. Spouses were also eligible unless claimed elsewhere.
Dependent Exemptions
Dependents often include your minor children, but you can claim others too. The IRS uses specific tests to define a dependent, typically a relative like a parent, child, sibling, aunt, or uncle who relies on you for support. Under the Tax Cuts and Jobs Act, the Child Tax Credit doubled to $2,000 per child from $1,000, though income thresholds limit the full amount you might receive.
Other Types of Exemptions
Beyond personal and dependent exemptions, there are many forms available. Not-for-profit organizations, U.S. citizens working abroad, low-income individuals, and other groups qualify for specific tax exemptions. You should consider these if they apply to your circumstances.
Exemption from Withholding
Employers withhold income tax from paychecks and send it to the IRS, but if you have no tax liability, you can request an exemption from this withholding. In that case, only Medicare and Social Security taxes are withheld, not income tax. Remember, the W-4 form you fill out when starting a job lets you specify withholding based on your status, exemptions, and dependents—it helps your employer calculate payments to tax authorities.
Income Exemptions
Some income is entirely exempt from taxes, such as earnings from municipal bonds, gifts up to $16,000 in 2022 or $17,000 in 2023, and distributions from health savings accounts used for qualified medical expenses. Qualified distributions from Roth 401(k)s and Roth IRAs are also tax-exempt.
What Is a Qualified Dependent?
A qualified dependent is someone who depends on you for financial support, usually children or relatives. The IRS sets the criteria, and only one taxpayer can claim a given dependent on their return.
What Type of Income Is Tax Exempt?
As I mentioned, municipal bond income is tax-exempt, along with HSA distributions for medical costs and qualified Roth plan withdrawals.
How Much Is the Standard Deduction?
For 2022, it's $12,950 for singles or married filing separately, and $25,900 for joint filers. In 2023, singles get $13,850, and joint filers $27,700.
Key Takeaways
- An exemption reduces the amount of income that would otherwise be taxed.
- Until the end of 2025, personal exemptions have been repealed and replaced by higher standard deductions.
- There are a variety of other exemptions and they can come in many forms.
- Certain income, such as income made from municipal bonds, counts as exempted income.
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