A tax benefit is a tax deduction, credit, or other allowance that ultimately helps individuals or businesses reduce their tax liability. You must typically meet certain eligibility requirements to qualify to claim a tax benefit.
Understanding tax benefits can help you improve your tax planning and save money. Here’s what you should know about how tax benefits work and how to make the most of them.
Definition and Examples of Tax Benefits
A tax benefit is a provision that allows taxpayers to pay less in taxes than what they would owe if that benefit were not in place. For example, a tax credit for qualified education expenses is a type of tax benefit.
Tax benefits can also apply to areas such as retirement planning. Many different types of retirement vehicles exist, and the tax benefits aren’t always the same, but they typically help you reduce your tax bill in the long run.
For example, with a traditional 401(k), the tax benefit is that you can reduce your taxable income based on the contributions to your retirement account. Then, your 401(k) investments can grow tax-free, and you don’t have to pay taxes until you withdraw the money later in life. In contrast, if you had deposited the money into a regular brokerage account, you wouldn’t be able to reduce your taxable income, and you would owe taxes on any capital gains and dividends earned.
A tax benefit can also apply to deferring taxes, which might help in situations where you need more cash in the present and can save up to pay taxes later. For example, as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, self-employed individuals were able to defer some Social Security taxes for the tax year 2020 to be paid in 2021 and 2022.
How a Tax Benefit Works
The IRS or other relevant agency sets rules in place to create a tax benefit that enables individuals or businesses to gain some sort of tax advantage.
In some cases, tax benefits are regulated by tax-specific laws. For example, the Tax Cuts and Jobs Act (TCJA) of 2017 affected many tax benefits—adding some and taking others away. One tax benefit added by the TCJA addressed how investments in areas known as Opportunity Zones could be eligible for deferred capital gains or even have those gains excluded from taxable income.
However, the law also removed some benefits. For example, employers had previously been able to provide tax-free moving expense reimbursements to employees. But after the TCJA, those types of payments count as part of an employee’s wages, so the employee would owe income tax and employment taxes on those reimbursements.
Tax benefits generally work by affecting tax withholdings and tax filings. When you do your taxes, for instance, you might claim a tax benefit like the student loan interest deduction (assuming you meet income requirements) or a tax credit.
If you’re an employee, you might also have less tax money withheld from your paycheck based on tax benefits. For example, if you take public transportation, you might be eligible to have your employer set aside some of your wages to pay for a commuter pass. This cost would reduce your taxable income, so you would net more money than if you were to get your regular paycheck and buy a monthly subway pass yourself.
What Tax Benefits Mean for Individuals
When it comes to taking advantage of tax benefits, it might often seem like you can do so automatically.
Generally, if you make 401(k) contributions or pay for part of your health insurance through your employer, your paycheck will reflect those deductions and reduce your taxable income. That means you don’t have to calculate those tax benefits yourself when it’s time to file your taxes. That may require some work on your employer or payroll processor’s end, but it’s generally not something you’ll have to handle.
Other times, however, you have to take action yourself. When filing your taxes, you might claim additional credits or deductions such as for making charitable contributions or investing in energy-efficient home improvements.
Using tax software or working with a qualified tax professional can help you figure out what tax benefits you qualify for and how to best use them to your advantage.
- A tax benefit is a rule that allows you to pay less in taxes than you would without the benefit.
- Tax benefits include tax credits, tax deductions, and tax deferrals.
- Some tax benefits can show up directly on your paycheck, whereas others have to be claimed on your tax return.
- Using tax software or working with a qualified tax professional can help you understand whether you qualify for tax benefits and how to use them.