How Does Being Tax-Exempt Work?
Tax exemptions are essentially an exception to a taxation rule from a government. If something is tax-exempt, then it is not subject to taxation, or it’s subject to a lower tax rate or only partial taxation. Tax exemptions can apply to a number of situations. For example, income from federal government bonds is generally exempt from state and local income taxes (while income from state and local bonds is generally exempt from federal income tax). An organization, such as a charity, school, or religious institution, can also be classified as tax-exempt. For example, the Internal Revenue Service (IRS) exempts qualified charitable organizations, among others from federal income tax. States might also designate an organization as tax-exempt. For instance, California has a separate application to designate an organization as exempt from income and franchise taxes. States can also designate an organization, such as schools, as being exempt from paying sales tax on purchases. The IRS has eliminated the personal tax exemption as a part of the Tax Cuts and Jobs Act, and the lowest federal income tax rate is 10% for taxable income up to $10,275, or $20,550 for married couples filing jointly for the 2022 tax year.
Examples of Tax Exemptions
Tax-exemptions can apply for different taxes, like federal or state. But just because there is a tax exemption under one jurisdiction, doesn’t mean that tax-exempt applies in another. For example, a nonprofit could be exempt from fees like property taxes on buildings it owns in one state, but not in another. To be federally tax-exempt, organizations generally need to apply for tax-exempt recognition and meet requirements such as not being organized for private interests. But, as the IRS points out, “nonprofit status is a state law concept.” Many other things are tax exempt. For example, many states exempt regular groceries from sales tax.
What Does Being Tax-Exempt Mean for Individuals?
Understanding what it means to be tax-exempt can help you or your organization optimize your taxes. If you know what types of investment income are tax-exempt, for example, you may consider how those types of earnings can fit into your portfolio to try to minimize your tax burden. Individuals may also want to understand what it qualifies as tax-exempt when they make decisions about their charitable giving.
