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Tax exemptions are an important aspect of tax planning that can greatly benefit individual taxpayers. They are specific types of deductions or exclusions from taxable income that can reduce the amount of taxes owed to the IRS. In this section, we will discuss what exemptions are, how they work, and why they are essential in tax planning.

What are exemptions and how do they work?

Exemptions refer to certain types of income or deductions that are not subject to taxation. They can be claimed by the taxpayer to reduce their taxable income and ultimately lower the amount of taxes they owe.  For example, if an individual earns $50,000 in a year and is eligible for a personal exemption of $4,000, their taxable income will be reduced to $46,000. This means they will only pay taxes on $46,000 instead of the full $50,000.

There are three main types of exemptions to consider: income, gift, and estate tax exemptions.

  • Income Tax Exemptions: These are deductions or exclusions from taxable income that taxpayers can claim to reduce their taxes owed. Personal exemptions for individuals and tax exemptions for non-profit organizations fall under this category.
    • The number of income tax exemptions that can be claimed varies depending on the specific exemption being used. Personal exemptions, for example, have a set dollar amount that can be claimed per individual. However, tax exemptions for an organization such as a non-profit may have different limits.
    • Looking ahead in 2024, there are some important individual income tax exemptions that taxpayers should be aware of. These include the standard deduction, itemized deductions, and the child tax credit.
  • Standard Deduction: This is a set amount that can be deducted from your taxable income without the need for any additional documentation. In 2024, the standard deduction has increased from 2023, providing a larger tax break for individuals. The standard deduction is now $14,600 for single filers and those married filing separately, $29,200 for joint filers and surviving spouse, and $21,900 for heads of household. There are also additions to the standard deduction for aged and/or blind taxpayers.
  • Itemized Deductions: These are deductions that can be claimed by individuals who have eligible expenses such as medical bills, mortgage interest, and charitable donations. It is essential to carefully consider whether itemizing or taking the standard deduction will result in reduced tax owed.
  • Child Tax Credit: This is a tax credit that parents or guardians can claim for qualifying children under 17. The amount of credit in 2024 is expected to remain the same as previous years, but it is still a valuable exemption to take advantage of.
  • Gift Tax Exemptions: These are exemptions that allow individuals to gift a certain amount of money or assets without incurring taxes. This is commonly used for gifting to family members, charitable organizations, and others.
    • As of 2024, the annual gift tax exemption limit is $18,000 per recipient. This means that an individual can gift up to $18,000 to as many people as they want without incurring any transfer tax.

Additionally, the lifetime exemption amount for gift and estate taxes has increased to $13.61 Million in 2024. This is the amount of money or assets that an individual can transfer over their lifetime or at their death without being subject to transfer tax. As always, it is crucial to stay updated on any changes in exemption limits and rules when utilizing them in your tax planning efforts.

  • Estate Tax Exemptions: These exemptions apply to the transfer of wealth after an individual’s death. Similar to gift tax exemptions, estate tax exemptions allow a certain amount of assets to be transferred without being subject to the estate tax.
    • The current estate tax exemption limit for 2024 is $13.61 million per individual. This means that any assets transferred after an individual’s death below this amount will not be subject to estate tax so long as they have not used their exemption during their lifetime. The IRS assesses a tax at graduated rates from 18% up to 40% for assets at death greater than the $13.61 million per individual threshold.
    • Be advised that on January 1, 2026, the estate and gift tax lifetime exemption will revert to the pre-2018 numbers, unless there is a specific action taken by Congress. Absent a new action, the exemption will reset to the 2011 rate of $5 million per person, with adjustments for inflation.

Common mistakes to avoid when utilizing exemptions.

When claiming exemptions, it is essential to understand the rules and regulations set by the tax authorities. Here are some common mistakes to avoid when utilizing exemptions:

  • Claiming ineligible exemptions: Not all deductions or exclusions can be claimed as exemptions. It is crucial to determine which ones you are eligible for before claiming them.
  • Failing to keep proper records: Exemptions often require supporting documents and records to be provided to the tax authorities. Failure to keep these records can result in disqualification of the exemption.
  • Exceeding exemption limits: Some exemptions have a limit on the amount that can be claimed. It is essential to stay within these limits to avoid any issues with the tax authorities.

Importance of Exemptions in Tax Planning

In conclusion, it is important to note that these exemptions and their limits may change in future years, so it’s important to stay informed and plan accordingly. It is recommended to regularly review your tax situation and consult with a professional for the best tax planning strategy, both for the current year and over the long term with regard to your estate and gift planning. Overall, exemptions are a valuable tool in reducing taxes owed and should not be overlooked in tax planning efforts. By understanding how they work and staying up to date on their limitations and benefits, individuals can effectively utilize exemptions to their advantage and lower their tax liability, along with participation in activities such as charitable giving which benefits society at-large. So, keep exemptions in mind when planning your taxes and don’t hesitate to seek professional advice for personalized guidance.

The MTC Team is comprised of licensed and certified wealth management professionals who can assist you with a wide variety of wealth management issues. To contact an MTC team member, visit our contact us page.

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