Allowances vs Exemptions: Difference and Comparison

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 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.

Key Takeaways

  1. Allowances are deductions from taxable income based on factors like marital status and dependents, while exemptions are deductions for specific expenses, such as medical costs or charitable donations.
  2. Allowances are no longer used in the US federal tax system but may still be used in some state tax systems.
  3. Exemptions were eliminated from the US federal tax system in 2018.

Allowances vs Exemptions

An allowance is an amount of money which can be deducted from the income before taxes are calculated. It is deducted based on specific expenses or situations. An exemption is a type of deduction that can be claimed for each dependent on the tax return. It is based on the number of dependents.

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Allowances are what your employer gives you to make up the difference in withholding tax. This type of income will never be reported on a W-form under most circumstances.

Exemptions 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
AllowancesExemptions
DefinitionAn 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.
AdvantagesFlexible Use and Easier to Claim (on Your Own).No Limits Based on Type of Expense or Child Qualifications.
DisadvantagesMay Be Limited Based on Paying for Child Care or Elderly Care.May Not Be Available to All Taxpayers (as Others Might be Eligible).
DeductionsIn allowances, the deductions are taken from the total income.In exemptions, deductions are given after deducting a specific amount.
DependentsIn 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 gift cards and loyalty programs offering free merchandise, do not have to be counted towards an individual’s earnings for tax purposes.

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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

  1. If a child is claimed as an exemption by more than one taxpayer, the exemptions are prorated based on the percentage of support provided.
  2. Allowances can be claimed on a person’s tax return, but exemptions cannot. At the same time, exemptions reduce the amount of taxable income available while allowances increase it.
Difference Between X and Y 2023 05 19T231952.147
References
  1. https://books.google.com/books?hl=hi&lr=&id=gYaJq2S6Ud0C&oi=fnd&pg=PT11&dq=Allowances&ots=VwxiyWus3W&sig=JjNj7zOSXwE3r8OFNZuSfsrvodY
  2. https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/hlr63&section=88

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