Did you know that there are several categories of income are not taxable in the eyes of the IRS?
Here are Some Examples
Note: The following are examples of nontaxable income. (This list is not all-inclusive.) In some cases, you may have to report nontaxable income on your federal income tax return even though it isn't subject to tax.
For more information on what the IRS considers taxable, see IRS Publication 525.
1) Financial Gifts
Financial gifts are a well-known category of non-taxable income. That's due in part to the generous annual federal gift tax limit. For example, for the 2023 tax year, you could give up to $17,000 to friends, family, or anyone else and not be taxed. (The person receiving the gift is never taxed, just the person giving the gift if they go over the limits.)
The gift tax limit for gifts given in 2024 has risen to $18,000. It is one of many IRS provisions that is adjusted annually for inflation. So you can give up to that amount to as many people as you want without incurring tax liability. (For married couples, the 2024 limit is $18,000 for each spouse).
- Charitable gifts are generally non-taxable, but be sure to get receipts and ensure the charities you give to are legit.
- Unfortunately, gifts given by employers to employees that are akin to cash, i.e., gift cards, are usually considered taxable by the IRS.
There are also some other employer-provided benefits and fringe benefits are not taxable. These include employer-provided health insurance, up to $50,000 of group term life insurance provided by your employer, and employer contributions to your health savings account (HSA) if you have one.
Generally, distributions from your HSA for qualified medical expenses are tax-free, while HSA distributions used for other purposes are subject to an additional 20% tax penalty.
If you are 65 or older, however, you can withdraw HSA funds for non-medical expenses without paying the additional tax penalty. But ordinary income tax rates still apply to distributions for other than qualified medical expenses.
2) Inheritances
The IRS doesn't consider inheritances to be taxable income. That includes inheritances of cash, property, etc.
Remember, though, that if the money you receive from an inheritance starts generating income, such as the interest from an interest-bearing account, those earnings may be taxable.
- Additionally, although there is no federal inheritance tax, some states tax inheritances.
- As of 2023, these states are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. (Iowa plans to fully phase out its inheritance tax by 2025.)
- However, few taxpayers overall pay state inheritance taxes due to varying exemptions.
Note: Not to be confused with inheritance tax (which is levied on the heirs of the deceased), the limit for the federal estate tax (levied on the estate) is quite high (i.e., $12.92 million for 2023 and $13.61 million for 2024), so most taxpayers can avoid the tax. Meanwhile, as of 2023, twelve states and the District of Columbia levy an estate tax.
3) Life insurance proceeds
Life insurance policy proceeds received by a beneficiary after the policyholder's death are generally tax-free. However, interest earned on the proceeds may be taxable, and tax rules can get complex if the policyholder surrenders the policy for cash.
The IRS has an online tool that can help determine whether life insurance policy proceeds you've received are taxable.
Are annuities taxable?
Different types of annuities are subject to different tax treatments. Generally, you pay taxes on annuities only once you start receiving payments or withdrawing funds. For example, earnings from non-qualified annuities are taxed upon withdrawal, while the contributions from after-tax dollars are not taxed.
Annuities are complex, so it's a good idea to seek advice from a trusted professional if you need clarification on your tax exposure.
4) Long-term care insurance income
Payments received from long-term care insurance policies are usually not subject to tax. So, if you receive reimbursements for medical expenses due to injury or illness under an accident and health insurance contract, these payments are generally considered nontaxable by the IRS.
5) Disability benefits
Disability and worker's compensation payments are generally nontaxable.
- Supplemental Security Income payments are also tax-exempt.
- Disability compensation or pension payments from the Department of Veterans Affairs to U.S. military Veterans are tax-free as well.
5) Municipal bond interest
I always recommend that you have some of these in your portfolio. Government-issued bond interest is mostly tax-exempt, but some muni interest may be taxable at federal and state levels. For example, U.S. Treasury securities are taxable at the federal level. Corporate bond interest is taxable at both the federal and state levels.
6) A portion of capital gains and losses
If your capital losses exceed your capital gains, you can claim up to a $3,000 loss as a deduction from your income. The deduction amount is the lesser of $3,000 ($1,500 if married filing separately) or the total net loss on Schedule D of your Form 1040. The IRS allows you to carry the loss forward to later years under specific rules.
- Also, if you meet certain criteria, you can avoid capital gains taxes on the first $250,000 (single filers) of your profits on the sale of your primary residence and up to $500,000 if married and filing jointly.
- A good tax professional can help make sure you get the right carry-over losses and homeowner exclusions.
7) Roth account income
Qualified distributions (i.e., from a Roth account at least five years old since you first contributed and when you are 59½ years or older) are tax-exempt. The IRS now allows you to make regular contributions to your Roth IRA at any age. Plus, you can leave any amount in your Roth IRA for as long as you live if you are thinking about leaving some tax free income to your heirs.
8) Alimony and child support
If you receive alimony or maintenance payments as part of a separation or divorce agreement made on or after January 1, 2019, those payments are not taxable. On the other hand, if you are paying alimony under such an agreement, you cannot deduct the payments from your income tax anymore either.
- Be aware that state tax treatment of alimony may differ.
- Child support payments are never subject to tax (it’s considered the child’s money).
9) Earned income in states with no income tax
Finally, if you live in one of the nine states without personal income tax — Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming — you won't be taxed on your earned income at the state level.
- However, Washington State has introduced a capital gains tax, and
- New Hampshire is phasing out its interest and dividend income tax.
Also, while some portion of your Social Security payments may be subject to federal tax, most states don't tax Social Security income.