Most of us want to lower our taxes, and if you're eligible for certain tax exemptions, then you could reduce the amount you have to pay the IRS. A tax exemption is an amount of money you're allowed to subtract from your taxable income. The more exemptions you're able to take, the more you can lower your tax bill.


Tax exemptions versus deductions and credits

Tax exemptions are similar to tax deductions in that they lower the amount of your income that's subject to taxes. Your ultimate savings, however, will depend on your effective tax rate. Say you earn $40,000 a year, you're eligible for $4,000 in tax exemptions, and your effective tax rate is 25%. This means you won't need to pay taxes on $4,000 in income, and you'll save $1,000 in taxes as a result. Meanwhile, a $4,000 tax deduction would provide the same savings and benefit.

Though they work similarly, there is a difference between tax exemptions and tax deductions: Exemptions are based on your filing status and the number of dependents you claim, while deductions are related to expenses you've paid throughout the tax year.

Tax credits, on the other hand, work differently. A tax credit is a dollar-for-dollar reduction of your tax liability. If you're eligible for a $4,000 tax credit, you'll actually get to subtract that $4,000 figure directly from your taxes, thus saving that amount in full. A $4,000 exemption will only save you $1,000.

Personal exemptions

U.S. tax filers are allowed to claim personal exemptions on their taxes. As long as no one else claims you as a dependent on his or her return, you can take one personal tax exemption for yourself on your own return. The personal exemption is a preset amount that typically changes (and ideally increases) year after year. If you're married and file a joint return with your spouse, then each of you is allowed to claim a personal exemption.

Exemptions for dependents

Though you might spend a lot of money to raise your children, the good news is that they can typically save you money on your taxes. You're allowed to take an additional tax exemption for each eligible dependent in your household. Your children must live with you for more than half the year or be under a certain age in order to qualify. Keep in mind that exemptions for dependents aren't just limited to your biological children. A niece or nephew who lives with you, for example, might give you an additional dependent exemption. For more details on which dependents qualify for an exemption, see Table 3-1 on this IRS webpage.

Tax-exempt organizations

Some organizations are designated tax-exempt by the IRS, meaning they are not required to pay federal income taxes. Typically, this status applies to non-profits and charitable groups. (Furthermore, those who donate goods or money to tax-exempt organizations can typically deduct the value of those donations from their taxable income.)

The good thing about tax exemptions is that they're fairly straightforward. Unlike tax deductions, which require you to add up your expenses and see whether it pays to itemize your deductions or simply take the standard deduction, tax exemptions are based on preset numbers and don't rely on heavy math. As long as you remember to claim the exemptions you're eligible for, it's a simple way to lower your taxes and hang on to more of your hard-earned money. 

This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at Thanks -- and Fool on!

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.