Companies and employees alike are always searching for ways to pay less in taxes. As it relates to employment, there are many programs that involve the employer-employee relationship that can help all sides do so.

For example, tax-advantaged retirement savings plans such as employer-sponsored 401(k) plans can help employees save for retirement on a pre-tax basis while also potentially taking advantage of “free money” in the form of employer matches.

These plans also provide tax advantages to businesses that offer them, too.

Similar tax advantages exist in other aspects of employee benefits, depending on what the company offers and what the employee takes advantage of.

Some of these come in the form of tax credits, while others are deductions or exclusions. But, what’s the difference between those three types of tax advantages?

Let’s take a look at each below.

What are Tax Credits?

Tax credits directly reduce how much you owe in taxes. When you calculate how much taxes you owe on your annual tax report, you subtract all qualifying tax credits that you have from that amount, which results in you owing less money.

While there are various types of tax credits, they are all dollar-for-dollar reductions. What this means is that if a tax credit is worth $2,000, your total tax bill will be reduced by that $2,000.

Many tax credits are known as what’s called nonrefundable. What this means is that the tax credit can’t exceed your total tax liability. It can only bring your liability down to $0.

Some tax credits are refundable, though. What this means is that if you meet certain eligibility requirements, you could take advantage of the benefit, even if it means getting a tax refund in your pocket.

What are Tax Deductions?

Tax deductions are essentially expenses that you subtract from your total gross income. A lower gross income means less tax liability, since it could drop you down a tax bracket according to the IRS’ categories.

Tax deductions might be familiar to you because the IRS actually has a standard deduction that they offer to all tax filers, regardless of status. How much is offered in this standard deduction varies depending on your filing status and the year.

For example, in 2024, the standard deduction for single filers or married couples who file separately is $14,600, while the standard deduction for joint filers is $29,200.

Some people may be able to use tax deductions to reduce their gross income in other ways. Self-employed workers, for instance, can deduct the amount they pay in health insurance premiums from their total income.

There are two main types of tax deductions from an accounting standpoint, which are known as above-the-line and below-the-line deductions. The “line,” in this term refers to your adjusted gross income, or AGI.

Above-the-line tax deductions are generally more advantageous to all people, because they lower your AGI. This could include HSA deductions, contributions to a traditional retirement plan, student loan interest and educator expenses.

All of these tax credits are taken off the top of your gross income to reduce your tax liability.

Below-the-line expenses only come into play if they exceed the standard deduction. If you made a $3,000 donation to your local church, for instance, that likely wouldn’t provide you a major tax benefit unless your total itemized deductions exceeded the standard deduction.

If the $3,000 donation was the only tax deduction you have, then it would be far more advantageous for you to take the standard deduction listed above, which in turn ultimately makes the donation not applicable from a tax standpoint.

What this all means is that above-the-line tax deductions are way more beneficial to most filers than below-the-line deductions. So, it’s important to know which is which, and where you fall come tax time.

What are Tax Exclusions?

Tax exclusions also reduce your total gross income, thereby reducing the amount of taxes you owe, but they do so in a different way than tax deductions do.

For example, some types of compensation are excluded, or exempt, from being considered taxable income. This means that you won’t pay any tax at all on the amount that is excluded.

Common examples of excluded income include insurance benefits, federal subsidies and retirement income.

If a company offers a health reimbursement arrangement, or HRA, to employees, the contributions that the employer makes to the plan are exempt from all payroll taxes. In addition, HRA reimbursements that employees use to pay for medical expenses also aren’t considered taxable income.

All of this helps to reduce your gross income by not forcing you to report these benefits as compensation.

Beckham Ellis Insurance Group Can Help You Figure Out Benefits Taxes

Figuring out all the different tax advantages that employer-sponsored benefits packages can provide can be quite complicated. That’s why it’s important to have an experienced and knowledgeable partner on your side.

At Beckham Ellis Insurance Group, our team of professionals can help you navigate the muddy waters of benefits to offer your employees the best package possible, with the greatest number of tax advantages to both them and your company.

If you’re in the Georgia or South Carolina region, please contact us today to learn more.