What Is a Tax Break?

The term tax break refers to a benefit the government offers that reduces your total tax liability. Tax breaks are made possible by tax laws and typically come in the form of credits and deductions. Other tax breaks include exemptions and excluding certain types of income from your state or federal tax return.

Tax breaks also refer to the favorable tax treatment certain groups receive. Churches and religious organizations, for example, are generally exempt from federal, state, and local income and property taxes, among other tax perks. Likewise, people affected by natural disasters receive tax breaks in the form of filing and payment extensions, penalty and interest waivers, and deductions for casualty and theft losses.

How Tax Breaks Work

The government provides tax breaks to individual and corporate taxpayers, greatly reducing their tax liabilities. Tax credits, deductions, exemptions, and tax exclusions may enable these savings.

In some cases, you don't have to take any action to get a tax break. For example, life insurance proceeds you receive are generally excluded from your taxable income—and you don't have to report them. However, to take advantage of most tax breaks, you must claim them (e.g., tax credits or deductions) on your income tax return and meet specific eligibility requirements.

Tax breaks can stimulate the economy by increasing the amount taxpayers have to spend and boosting what businesses can invest in their growth. Moreover, tax breaks can promote certain behaviors that benefit society, such as replacing gas-guzzling cars with modern fuel-efficient vehicles.

As noted above, tax breaks are implemented because of state and federal tax laws. Regulations outline how tax breaks work, who qualifies, and (in some cases) how long the tax break lasts. The U.S. Congress and the president are responsible for approving federal income tax laws. For instance, Congress approved the Tax Cuts and Jobs Act (TCJA), which made significant changes to the U.S. tax code and was signed into law in 2017 by then-President Donald Trump.

Types of Tax Breaks

Tax Credits

A tax credit reduces your tax liability on a dollar-for-dollar basis. This has a greater impact than a deduction, which merely reduces the amount of income subject to taxes. A tax credit is applied to the amount of tax you owe after all deductions are taken from your taxable income. For example, if you owe $3,000 in taxes and are eligible for a $1,100 tax credit, the amount you owe decreases to $1,900 ($3,000 - $1,100) after the tax break is applied.

Corporations can also take advantage of tax credits to lower their tax bills. The government permits these to benefit workers and the national economy. Certain credits are implemented regardless of the industry or sector, such as business tax credits, investment credits, and credits for child care for workers. They can also be more industry-specific, such as those in the agricultural, energy, and mining sectors.

Tax Deductions

Tax deductions are expenses that can be subtracted from your gross income to reduce your taxable income—and therefore, your tax bill. For example, a $1,000 tax deduction would lower your taxable income by that same amount. The value of the deduction depends on your tax bracket. So, if you are in the 22% tax bracket, that $1,000 tax deduction would save you $220 ($1,000 × 22%) on your tax bill.

Most taxpayers have the option to take the standard deduction (a fixed dollar amount based on your filing status) or itemize their deductions on of Form 1040 or 1040-SR. Here's a rundown of the standard deduction amounts for 2022 and 2023:

• Mortgage interest on the first $750,000 of secured mortgage debt (or $1 million if you bought the home before Dec. 16, 2017)
• Unreimbursed medical and dental expenses that total more than 7.5% of your adjusted gross income (AGI)
• Up to $10,000 in state and local taxes
• Charitable contributions
• Casualty and theft losses
• Gambling losses
  

Tax Exclusions

A tax exclusion shelters a certain portion of income or type of income from taxation. For example, you can generally exclude child support payments, life insurance proceeds, and municipal bond income from your taxable income. Likewise, health insurance premiums your employer pays are exempt from federal income and payroll taxes, and the portion of premiums you pay is generally excluded from your taxable income.

Another common tax exclusion pertains to home sales. If you have a capital gain from selling your main home, you can exclude up to $250,000 ($500,000 if married filing jointly) of that gain from your income. To qualify, you must:

• Have owned and lived in the home for at least two out of the previous five years
• Not have excluded the gain from the sale of another home within the past two years

Also, if you earn income in a foreign country, you may be eligible for a tax break through the foreign earned income exclusion. The total for an individual is $112,000 for the 2022 tax year and $120,000 for the 2023 tax year.

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