What is the difference between a tax deduction and a tax exemption?

by fred.nader , in category: Taxation and Accounting , 9 months ago

What is the difference between a tax deduction and a tax exemption?

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1 answer

by elizabeth , 9 months ago


A tax deduction and a tax exemption are both ways to reduce your taxable income, but they have different meanings and applications.

  1. Tax Deduction: A tax deduction is an expense or cost that you can subtract from your taxable income, ultimately reducing the amount of income that is subject to taxation. Deductions are typically based on eligible expenses such as mortgage interest, student loan interest, medical expenses, charitable contributions, and business expenses. The amount of the deduction depends on the specific rules and limitations set by the tax laws.
  2. Tax Exemption: A tax exemption, on the other hand, is an exclusion or exception that allows certain types of income or individuals to be exempt from paying taxes altogether. In other words, exempt income is not included in your taxable income, and therefore, you do not have to pay taxes on it. Tax exemptions are often granted based on various factors such as certain types of income (e.g., interest on municipal bonds) or specific individuals or organizations (e.g., religious institutions, non-profit organizations).

In summary, a tax deduction reduces the amount of your taxable income, while a tax exemption excludes certain income or individuals from being subject to taxation. Deductions reduce the tax liability by a percentage based on expenses, while exemptions remove the tax liability altogether for specific income or entities.