Tax Break
A tax break is a reduction of a taxpayer’s total liability. There are three types of tax breaks: a tax deduction, a tax credit, and a tax exemption. If the government gives a tax break to a particular group of people or type of organization, then it reduces the amount of tax that they otherwise would have to pay or changes the tax system in a way that benefits them. The savings may be enabled by a tax deduction, a tax credit, or a tax exemption. In effect, a tax credit is applied to the amount of tax owed by the taxpayer after all deductions are made from the person’s taxable income.
What Is a Tax Break?
A tax break is a reduction of a taxpayer’s total liability. The term is also used to refer to the favorable tax treatment of any class of people in the United States.
If the government gives a tax break to a particular group of people or type of organization, then it reduces the amount of tax that they otherwise would have to pay or changes the tax system in a way that benefits them.
Understanding a Tax Break
A tax break can greatly reduce a taxpayer’s liability. The savings may be enabled by a tax deduction, a tax credit, or a tax exemption.
Tax breaks are often explained as a means to stimulate the economy by increasing the amount that taxpayers have to spend or that businesses have to invest in their growth.
They also are used to promote certain types of behaviors that are seen as beneficial, such as the replacement of gas-guzzling cars with modern fuel-efficient vehicles.
Types of Tax Breaks
Tax Deductions
Tax deductions are expenses that can be subtracted from gross income to reduce taxable income.
For example, if a single filer’s taxable income for the tax year is $75,000, then the person will fall in the 22% marginal tax bracket for 2020 and 2021. The total marginal tax bill will be 22% × $75,000 = $16,500. However, if that person qualifies for an $8,000 tax deduction, then the income taxed will be $75,000 − $8,000 = $67,000 taxable income, not $75,000. That reduces the person’s tax bill to $14,740.
The reduction of taxable income is a tax break for the taxpayer, who ends up paying less to the government.
Tax Credits
A tax credit reduces a taxpayer’s tax liability dollar-for-dollar. That has a greater impact than a deduction, which merely reduces the amount of income subject to taxes.
In effect, a tax credit is applied to the amount of tax owed by the taxpayer after all deductions are made from the person’s taxable income. If an individual owes $3,000 to the government and is eligible for a $1,100 tax credit, then the amount owed will be reduced to $1,900 after the tax break is applied.
Tax Exemptions
An exemption screens a certain portion of income or type of income from taxation.
For example, an expatriate who earns income in a foreign country is eligible for a tax break of $107,600 as of the 2020 tax year. This is applied through the foreign earned income exclusion (FEIE).
An ex-pat who earns $180,000 for a job in a foreign country, for example, will be taxed only on the amount that exceeds $107,600, or $72,400.
Charitable organizations and religious institutions are generally tax-exempt. That is, they are not required to pay federal income taxes.
Related terms:
Additional Child Tax Credit
The Additional Child Tax Credit was the refundable part of the Child Tax Credit. The refundable credit was revamped under the Tax Cuts and Jobs Act. read more
American Opportunity Tax Credit (AOTC)
The American Opportunity Tax Credit is a credit for expenses incurred in the first four years of post-secondary education. read more
Child and Dependent Care Credit
Child and dependent care credit is a nonrefundable tax credit for unreimbursed childcare expenses paid by working taxpayers. read more
Child Tax Credit
This $2,000-per-child credit covers children under 17; $1,400 is refundable. In 2021, it's $3,000 for under 18s ($3,600 under 6) and fully refundable. read more
Dependent
A dependent is a person who entitles a taxpayer to claim dependent-related tax benefits that reduce the amount of tax that the taxpayer owes. read more
Earned-Income Credit (EIC)
The earned-income credit (EIC) is a tax credit in the U.S. that benefits certain taxpayers who earn low incomes from work in a particular tax year. read more
Educator Expense Deduction
The educator expense deduction is a tax break for teachers and other education professionals for up to $250 in out-of-pocket expenses. read more
Foreign Earned Income Exclusion
The foreign earned income exclusion excludes income earned and taxed in a foreign country from the U.S taxable income of American expats. read more
Foreign Tax Credit
The foreign tax credit is a nonrefundable tax credit for income taxes paid to a foreign government as a result of foreign income tax withholdings. read more
General Business Tax Credit
The general business tax credit is the total value of all the individual credits to be applied against income on a tax return. read more