Allowances and exemptions can be confusing. It’s important to know the difference between them, so you don’t end up paying too much tax! Allowances are typically not taxable because they are given as a form of income.
The IRS has many different types of allowances and exemptions for various situations that may arise in life, but this blog post will focus on just four: the standard deduction, dependent care spending account allowance, education savings account allowance, and retirement savings contribution credit allowance.
Allowances vs Exemptions
The difference between allowances and exemptions is that allowance is a form of income that is not taxable, while exemption reduces your taxable. Allowances are usually provided by employers, while exemptions come from the federal government. Allowances, also known as “above-the-line deductions,” can be taken on your tax return without needing any additional forms or calculations. On the other hand, exemptions need to be applied for through your state department of revenue before you can take them off your income. Allowances are typically more advantageous than exemptions because they do not require paperwork beforehand.
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Allowances are what your employer gives you to make up the difference of withholding tax. This type of income will never be reported on a W-form under most circumstances.
Exemptions usually reduce taxable income for either personal use, such as owning your home or driving to work or in some cases, it can be transferred to another person by means of a gift.
Comparison Table
| Parameters of Comparison | Allowances | Exemptions |
|---|---|---|
| Definition | An allowance is a fixed sum that an employee receives from their employer to use for the expenses associated with performing their job. | An exemption is a type of deduction that reduces taxable income. |
| Advantages | Flexible Use and Easier to Claim (on Your Own). | No Limits Based on Type of Expense or Child Qualifications. |
| Disadvantages | May Be Limited Based on Paying for Child Care or Elderly Care. | May Not Be Available to All Taxpayers (as Others Might be Eligible). |
| Deductions | In allowances, the deductions are taken from the total income. | In exemptions, deductions are given after deducting a specific amount. |
| Dependents | In allowances, dependents can claim themselves. | But in exemptions, only one person is allowed to be claimed as a dependent. |
What are Allowances?
Allowances come in all forms and can allow you to reduce your taxable income. This can be done by either giving allowances that offer cash, reimbursements, or benefits-in-kind (BIK).
Allowances are tax deductions offered by employers to their employees. Employers can offer different types of allowances for personal use, such as cell phones or free parking spaces on the work premises.
Allowances can also come from other sources, such as professional registration bodies or government departments that give out special work-related permits or licenses.
Tax-exempt allowances, such as certain gift cards and loyalty programs that offer free merchandise, do not have to be counted towards an individual’s earnings for tax purposes.
What are Exemptions?
Exemptions are income categories that you can choose to apply for, where your income falls into one of these categories.
For example, if you’re eligible for an exemption due to low income or age, then this means that you don’t have to pay taxes on that portion of your income.
These tax deductions come from specific items or expenses incurred during an employee’s job-related activities, which can include tools and equipment-related activities, travel allowance expenses for work-related activities, and expenses for uniforms.
Exemptions are also used to reduce an individual’s taxable income, but they differ from allowances because exemptions do not have a cash value and will only apply under certain circumstances.
Both allowances and exemptions have a cash value, but there are differences in when they can or will apply to an individual’s tax return.
Main Differences Between Allowances and Exemptions
- If a child is claimed as an exemption by more than one taxpayer, the exemptions are prorated based on the percentage of support provided.
- Allowances can be claimed on a person’s tax return, but exemptions cannot, while exemptions reduce the amount of taxable income available while allowances increase it.
- https://books.google.com/books?hl=hi&lr=&id=gYaJq2S6Ud0C&oi=fnd&pg=PT11&dq=Allowances&ots=VwxiyWus3W&sig=JjNj7zOSXwE3r8OFNZuSfsrvodY
- https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/hlr63§ion=88
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
