Tax Benefit: Definition, Types, and IRS Rules

What Is a Tax Benefit?

The term “tax benefit” refers to any tax law that helps you reduce your tax liability. Benefits range from deductions and tax credits to exclusions and exemptions. They cover various areas, including programs for families, education, employees, and natural disasters.

Some tax benefits are related to the ability to pay taxes. For example, the Child Tax Credit and the earned income tax credit (EITC) recognize the cost of raising a family. Other tax benefits, including mortgage interest and charitable donation deductions, are incentives designed to further social policy goals.

Understanding Tax Benefits

Tax benefits help individuals and corporations reduce their overall tax bills. These benefits are a significant part of the tax regulations and legislation set by local, state, and federal governments.

Tax benefits such as deductions, credits, exemptions, and exclusions reduce the amount you owe annually to federal and state governments.

On the other hand, tax shelters help lower taxes through particular investments. These are legal vehicles that provide favorable tax treatment. Common examples of tax shelters include municipal bonds and employer-sponsored 401(k) plans.

Eligibility

You must be eligible for tax benefits to claim them. For instance, to qualify for head of household status, you must be unmarried, have a qualifying dependent who lives with you, and pay more than half of the household expenses for the year.

Tax benefits for educational expenses can only be claimed by those who spend money on tuition and other related costs during the tax year.

It makes financial sense to learn about any tax benefits you might be eligible for. Without the proper knowledge, you could end up paying more in taxes than you owe. It can be helpful to consult a tax professional, such as an accountant, to maximize your tax savings.

Types of Tax Benefits

As noted above, tax benefits come in all shapes and sizes. We’ve highlighted some of the more common ones below.

Tax Deductions

A tax deduction reduces your taxable income. When you file your annual income tax return, you have the option to take the standard deduction or to itemize your deductions:

• Standard Deduction: The standard deduction is a fixed dollar amount that reduces taxable income. For 2024, the standard deduction is $14,600 for single filers and married taxpayers filing separately, $21,900 for heads of household, and $29,200 for married couples filing jointly and surviving spouses. For 2025, these figures increase to $15,000, $22,500, and $30,000, respectively.
• Itemized Deductions: Itemized deductions are qualified expenses allowed by the Internal Revenue Service (IRS) to decrease your taxable income by listing them on Schedule A of your tax return. The sum of your itemized deductions reduces your adjusted gross income (AGI). There is no limit on itemized deductions for tax years 2024 or 2025 due to the Tax Cuts and Jobs Act.

Itemizing your deductions makes sense if the sum of your qualified expenses is greater than your standard deduction. For example, if a single taxpayer’s itemized expenses total $15,000, they would likely itemize rather than take the $13,850 standard deduction. However, if the same filer’s qualified expenses total just $8,000, they would save money by taking the standard deduction.

Even if you don’t itemize, you can take certain above-the-line deductions along with the standard deduction. These include deductions for student loan interest, traditional individual retirement account (IRA) contributions, contributions to Health Savings Accounts, and more. All these deductions lower taxes by reducing taxable income and possibly lowering your tax bracket.

Say, for example, that a single filer has $49,000 of taxable income for the 2024 tax year, landing them in the 22% marginal tax bracket. Therefore, they would pay 22% on any income over $47,150 (the beginning of the 22% tax bracket).

However, if they qualify for $2,000 in above-the-line tax deductions, they will be taxed on $49,000 - $2,000 = $47,000, giving them a marginal tax rate of 12% for tax year 2024.

Tax Credits

Tax credits also save you money, but they work differently from deductions. A tax credit is applied to the amount of tax you owe after all tax calculations are made. For example, if you owe $3,000 after taking deductions and calculating taxes with your marginal tax rate, a $1,000 credit would reduce your tax bill to $2,000.

There are many types of tax credits available for individuals and businesses. For individuals, some of the most common tax credits include the Child Tax Credit, the EITC, and the premium tax credit.

Refundable Tax Credit

Tax credits are either refundable or nonrefundable. A refundable tax credit results in a refund check if the tax credit exceeds your tax bill. For example, say you apply a $3,400 tax credit to your $3,000 tax bill. Your bill would be reduced to zero, and you would receive the remaining portion of the credit as a refund. In this case, that refund would be $400.

Nonrefundable Tax Credit

A nonrefundable tax credit does not result in a refund because it only reduces the tax owed to zero. Using the example above, if the $3,400 tax credit were nonrefundable, you would owe nothing to the government but would forfeit the $400 that remains after the credit is applied.

Some examples of nonrefundable tax credits include the saver’s credit, adoption credit, child care credit, and mortgage interest tax credits.

Exemptions and Exclusions

The Tax Cuts and Jobs Act (TCJA) suspended the personal tax exemption for 2018 through 2025, but some tax exclusions still apply.

Tax exclusions usually arise in pretax payments that help you lower your taxable bottom line. Income excluded for tax purposes usually does not show up on your tax return at all.

One of the most common exclusions is the employer-based health insurance payment program. If an employer takes healthcare payments on a pretax basis, an employee’s taxable income is lowered at the end of the pay period, which reduces the amount of tax owed.

Tax Shelters

A tax shelter provides a variety of tax advantages. It is generally a vehicle with lower or no tax requirements if you abide by the contracted terms.

One of the most popular tax shelters is the 401(k). That’s because income is sheltered from a higher tax rate during investors’ higher-earning years compared to in retirement, when their income (and tax rate) is lower.

Tax havens can also be a type of tax shelter. These are often used by businesses. Companies may incorporate in certain regions to lower their business tax bill. Some of the most popular tax havens include Bermuda, the Bahamas, and the Cayman Islands.

Certain investment products may offer a tax shelter or tax exemption in and of themselves.

Municipal bonds, for example, are exempt from federal and state taxes if aligned with the state in which the bondholder lives.

Other tax-advantaged investments include tax-free savings accounts, municipal mutual funds or exchange-traded funds (ETFs), and some life insurance policies.

The Bottom Line

It’s important to know where you stand with respect to your tax bill even if it isn’t tax season. Keeping on top of the tax benefits that apply to you can spell the difference between a refund and an unwelcome tax bill—or at least breaking even when it comes time to file.

These benefits range from tax credits and deductions to exclusions and exemptions. Be sure to speak to a tax professional if you’re unsure about how they may work for you.