Definition
A personal exemption refers to a specific amount of income that an individual can claim as a tax deduction to lower their taxable income. Each person can claim one personal exemption for themselves and each dependent they can claim on their tax return. However, it’s essential to note that this is no longer available for tax years 2018 through 2025 due to changes in the tax code brought about by the Tax Cuts and Jobs Act.
Key Takeaways
- Personal Exemption refers to the specific amount of income that a taxpayer is able to claim as a deduction from their total income for tax purposes. It’s strategically designed to reduce the taxable income of the taxpayer.
- Personal Exemptions can generally be claimed for the taxpayer and any other individuals they are financially responsible for, such as a dependent child. The value of each personal exemption is typically adjusted annually for inflation.
- As of the 2018 tax year in the U.S., the traditional personal exemption has been suspended by the Tax Cuts and Jobs Act. However, individual taxpayers can still take advantage of the increased standard deduction.
Importance
Personal Exemption is a crucial finance term as it directly impacts an individual’s taxable income.
It refers to a certain amount of income that a taxpayer is allowed to exclude from their taxable income each year, thereby reducing their overall tax liability.
The importance of personal exemptions lies in their ability to potentially lower a taxpayer’s overall tax bill.
This provision for deductions can alleviate the financial burden for individuals with dependents or families, making it more manageable to meet their tax obligations.
However, the value of personal exemptions and who may qualify can change based on tax law revisions, emphasizing the importance of staying informed about current regulations.
Explanation
The personal exemption is a fundamental concept in personal income taxation that serves the purpose of providing tax relief to taxpayers. Essentially, it is a specific amount of income that the tax system allows taxpayers to exclude from their taxable income each year.
The personal exemption serves to ensure that all taxpayers have enough income to meet basic living expenses. Thus, it is a buffer created to protect a minimal level of income from being taxed, thereby reducing the overall tax liability of individuals and helping them to maintain a reasonable standard of living.
The personal exemption plays a vital role in the progressive structure of the income tax system. It acts as a progressive element in the tax code because it provides greater benefit to lower-income individuals and families, for whom the exempted amount represents a larger proportion of income.
Additionally, Personal exemptions, along with the standard deductions and itemized deductions, help reduce the taxable income and thereby the tax burden of individuals. The exact amount eligible for personal exemption often varies and is determined by the tax laws during each tax year.
Examples of Personal Exemption
**Tax Return**: In the United States, prior to the tax reform in 2018, individuals could reduce their taxable income via a personal exemption. For instance, if a taxpayer earned $40,000 in one year and the personal exemption amount was $4,050, they would only be taxed on $35,950 of their income.
**Dependent Exemption**: In the past, taxpayers could also claim personal exemptions for each of their dependents. For example, if a family had two parents and three children, they could claim five personal exemptions, significantly reducing their taxable income.
**Non-resident Aliens**: Non-resident aliens in the US could claim one personal exemption under previous tax law, unless a tax treaty allowed for more. This situation provided a tangible real-world example of a personal exemption in motion, allowing for reduced taxable income for individuals living and working within the United States, but maintaining citizenship elsewhere. Note that the Tax Cuts and Jobs Act, enacted in 2018, eliminated personal exemptions from 2018 until at least
FAQs about Personal Exemption
What is a Personal Exemption?
A Personal Exemption is a certain amount of income that an individual can claim as a tax exemption each tax year.
How does a Personal Exemption work?
A Personal Exemption works by reducing your taxable income. You can claim one for yourself and, if you’re married, one for your spouse as well. This can help lower your overall tax burden.
Who is eligible for a Personal Exemption?
Typically, you may claim a personal exemption for yourself unless another taxpayer is entitled to claim you as a dependent. The rules can vary, so it’s best to consult a tax professional.
What happened to Personal Exemption?
Starting in 2018, the Personal Exemption was eliminated following the passing of the Tax Cuts and Jobs Act. It is currently set to return in 2025 unless Congress acts to extend the law.
Can I still claim Personal Exemption?
As of the 2020 tax year, you cannot claim a Personal Exemption. It was suspended until the tax year 2025 under the Tax Cuts and Jobs Act of 2017.
Related Entrepreneurship Terms
- Adjusted Gross Income
- Tax Deduction
- Standard Deduction
- Dependent exemption
- Itemized Deduction
Sources for More Information
- Internal Revenue Service (IRS): The IRS is a U.S. government agency responsible for tax collection and tax law enforcement.
- Investopedia: A comprehensive online financial dictionary that provides definitive explanations of financial terms.
- Nolo: Nolo provides legal, business, and personal finance advice through high-quality content and software.
- The Motley Fool: A financial and investing advice company. They provide a variety of advice on various investment and financial topics.
