Figure out what it means to be tax exempt, what kind of tax exemptions are available, and whether this tax status applies to you at all.
You’ve likely heard the term "tax exempt" thrown around during tax season, but what does it actually mean? Being tax exempt can be a status that applies to you, portions of your income, or your business or organization.
Whether you’re a business or organization looking to understand what tax exemptions might apply to you, or an individual looking to understand your taxes better, we have all the information you need to understand what it means to be tax exempt.
What Tax Exempt Means
Tax exempt is a tax status that excludes an individual or organization from a certain tax obligation. A person, organization, or a portion of income can be tax exempt, meaning it is free from paying certain taxes. The IRS offers tax exemptions to provide tax relief for individuals and organizations under certain conditions or situations, like nonprofit entities
For example, a nonprofit charity organization may qualify for a tax exempt status, meaning this organization wouldn’t need to pay federal income tax on any money they receive.
In order for a person, organization, or portion of income to qualify for tax exempt status, it first needs to meet certain requirements. These requirements vary depending on the entity and income involved.
Types of Tax Exempt Income
Tax exempt income is certain types or portions of income that are not subject to being taxed. Some types of income are exempt from federal income tax and some income may even be exempt from state taxes depending on where you live.
Tax Exempt Interest Income
One type of income earnings that may be free from tax obligations is income earned from interest. Specifically, interest you earned on certain investments like municipal bonds may be eligible for exemption.
Municipal bonds are a type of investment bond issued by the state or city. These bonds help raise funds for the local government, so the interest earned on this type of investment may be free from income tax.
Health Savings Account (HSA) Withdrawals
An HSA is a type of savings account that helps you save specifically for medical expenses. Any withdrawals you take out of an HSA account are for medical expenses, making any amounts you withdraw from this account exempt from being taxed.
Health savings account contributions may not be tax exempt, but they may be tax deductible. This means you can deduct your HSA contribution amounts from your total taxable income.
Roth IRA Distributions
A Roth IRA is a type of retirement account (specifically a type of Individual Retirement Account, IRA) that helps you save specifically for retirement. A Roth IRA distribution is a withdrawal from this account. Withdrawals you take out of a Roth IRA account have to meet very specific requirements, making amounts you withdraw from this account exempt from being taxed.
Social Security Benefits
Social Security benefits include money you receive from the Social Security program for things like retirement or disability insurance. If you received Social Security checks in the last tax year, then a portion of that income may be exempt from income tax.
How much of your Social Security Benefits are tax exempt depends on your total income and your tax filing status. For example, if your Social Security Benefits are your only source of income then a larger portion of this income may be free from income tax.
Veterans Benefits
Veteran Benefits include money or financial assistance received from the US Department of Veterans Affairs Veteran Benefits program for things like disability compensation, pensions, or education. If you received Veteran Benefits in the last tax year, then a portion of that may be exempt from taxes.
Tax Exempt Organizations
- Charitable Organizations
- Churches or Religious Organizations
- Educational Organizations
- Social Welfare Organizations
- Private Foundations
- Political Organizations
- Other Nonprofits
The reason organizations like these are sometimes eligible for a tax exempt status is because they generally make their “income” from donations rather than profits. They also often provide public services and benefits to communities.
Tax Exempt Organization Requirements
To be a tax exempt organization, you have to meet several requirements that may vary depending on the type of entity and finances involved. You can find these requirments outlined in the Internal Revenue Code Sections 501(a) and 501(c)(3). Some of those requirements include things like detailed financial reporting, annual tax filing, and more.
Tax Exempt Forms
There are many tax exempt forms that are used to apply for exemptions or report portions of exempt income that need to be filled out along with tax returns each year. Some examples of tax exempt forms include:
- Form 1023: Used to apply for recognition of exemption under section 501(c)(3).
- Form 1024: Used by non-501(c)(3) organizations to apply for recognition of exemption under section 501(a) or 501(c).
- Form 990: Used by tax exempt organizations to file annual tax returns.
- Form 8038: Used to tax exempt interest income from bonds issued by municipalities or states.
- Form 4361: Used by ministers, members of religious orders, and Christian science practitioners to apply for exemption from self-employment tax.
- Form 4029: Used by members of recognized religious groups to apply for exemption from social security and medicare taxes.
IRS Tax Exempt Organization Search
The IRS keeps a database of tax exempt organizations. You can search for an organization by visiting the link below and entering the Employer Identification Number (EIN), city, and state of the organization. You can also search by the organization's name instead of EIN.
How to Apply for Tax Exempt Status
To apply for tax exempt status, you’ll first need to determine whether your organization is eligible for this status. The first requirement is for the organization to have the right legal form: a trust, corporation, or association.
- Must be a trust, corporation, or association
- Must have an Employer Identification Number (EIN)
- Must have an exempt purpose
- Must have an exact copy of the organization's organizing document (for example, Articles of Incorporation, Articles of Association, Trust Agreement, etc.)
- Must have financial information (for example, receipts, expenditures)
These are just a few of the things an entity must have in order to apply for tax exempt status. To go through the entire application process visit the link below and go through each question about your organization.
What are Tax Exemptions?
Tax exemption is a tax relief benefit that excludes all or a portion of an individual or organization’s income from a certain tax obligation. Certain kinds of income, earnings, or withdrawals can sometimes be eligible for tax exemptions, meaning that all or a portion of those earnings could be free from income tax.
The IRS offers tax exemptions to provide tax relief for certain kinds of earnings like withdrawals from certain accounts, earnings from certain kinds of investments, or certain types of income. However, since the Tax Cuts and Jobs Act of 2017 federal tax exemptions have mostly been replaced by tax credits and deductions instead. State tax exemptions depend on what state you live in.
The Tax Cuts and Jobs Act of 2017
The Tax Cuts and Jobs Act of 2017 was passed in December 2017. Some of the changes in this act are set up to be reverted back in December 2025. One of the primary reasons for the Tax Cuts and Jobs Act of 2017 was to make tax filing and tax forms easier and simpler for the individual taxpayer.
Personal exemptions for individuals used to exist but are no longer in effect after 2018. Instead, individual taxpayers can apply for tax deductions and tax credits.
The Tax Cuts and Jobs Act of 2017 Includes:
The following is a simplified list of what the tax cuts and jobs act includes. This list can give you a general understanding of what the act means for the average taxpayer.
- Changed itemized deductions
- Changed the alternative minimum tax
- Expanded standard deduction
- Expanded the child tax credit
- Lowered tax rates
- Simplified the tax filing process
- Added new limits to some itemized deductions
Types of Tax Exemptions
While most federal tax exemptions have been replaced with tax credits and deductions, some forms of income are still eligible for exemption, and some states still offer certain tax exemptions for state taxes.
Tax Exempt Income
All or a portion of some types of income can be exempt from income tax. For example, income earned from eligible types of interest income, health savings account (HSA) withdrawals, Roth IRA distributions, Social Security Benefits, or Veterans Benefits may be eligible as tax exempt income.
Capital Gains Tax Exemption
A capital gain is the profit you make from the sale of an asset. Some types of captial gains are exempt from taxation.
Sales Tax Exemptions
Some states offer a sales tax exemption that allows businesses to make certain purchases without paying sales tax. For example, if a business purchases something for resale, then that purchase may be eligible for an exemption from sales tax depending on which state your business operates in.
Homestead Exemption
A homestead exemption can protect homeowners from losing their primary residence in the event of a death in the household. The homestead exemption can also sometimes apply to cases of bankruptcy.
Primary Residence Exemption
Some states offer a property tax exemption that allows homeowners to only pay property tax on a percentage of their home’s market value, rather than paying property tax on their home’s full value. This helps reduce homeowner's property tax obligation depending on which state your home is located in.
Tax Exemptions vs Deductions vs Credits
What’s the difference between tax exemptions, deductions, and credits? They all reduce your tax obligation, but they do so in different ways.
The main differences are that tax exemptions exclude certain types of income from being taxed, while tax deductions reduce total taxable income before taxes are applied, and tax credits reduce total taxes owed after taxes are applied.
