A tax-free allowance is an amount of income that you can earn each year without paying tax on it. The amount of tax-free allowance varies depending on the country and the individuals circumstances. For example, in the UK, everyone, including students, has a personal allowance, which is the amount of money you’re allowed to earn each tax year before you start paying Income Tax. For the 2023/24 tax year, the Personal Allowance is £12,570. In the US, certain foreign areas allowances, cost of living allowances, and travel allowances are tax-free.

In the context of military compensation, most allowances are tax-exempt, while all pays are taxable. The primary allowances for most individuals are BAS and BAH, which are tax-exempt. In addition to being tax-exempt from Federal and State taxes, these allowances are also excluded from Social Security taxes.

In the past, tax allowances were used to reduce the amount of income tax an employee had to pay. A withholding allowance was like an exemption from paying a certain amount of income tax. So when you claimed an allowance, you would essentially be telling your employer (and the government) that you qualified not to pay a certain amount of tax. However, personal exemptions, which were used to calculate withholding allowances, have been eliminated by the Tax Cuts and Jobs Act for 2018 through 2025. Instead, employees fill out a W-4 form to tell their employer how much to withhold from their pay.