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15 kinds of Tax-Free Income

I love it when I get a call from someone asking me how much tax they will have to pay on something, and I get to say ‘zero.’ They get so excited when they have tax-free income and the taxman isn’t going to take half of it. That makes my day (and the math is easy, too).

Everything that  ‘comes in’  is not  ‘in-come’

The IRS considers everything that comes under your control to be income. If you are audited, they look at every deposit into your accounts. However, many things are ‘excluded’ from income. Exclusions don’t count in any calculation, are not reported on any tax form, and are tax-free income.

Here are a few:

  1. Inheritance – Inheritance comes to you tax-paid and at fair market value as of the day you loved-one died. Sometimes, estates continue to make money after the owner is deceased. That is taxable and comes to you on a K-1.
    If you inherit tax-deferred funds like an IRA or 401k, taxes were never paid on the earnings and so they are taxable.
  2. Gifts you receive – Gift tax is paid by the giver, if it is required.
  3. Loan proceeds you receive – Loans need to be paid back, so they aren’t income. If your debt is cancelled, then it becomes income. BUT…
  4. Cancelled debt on your residence (2020 rules) and any other cancelled debt (if you were insolvent at the time) are excluded from income and tax-free.
  5. Employee benefits (health insurance, parking space, coffee) – Not everything qualifies as ’employee benefits’. Specific rules from the IRS govern employee benefits.
  6. Life insurance proceeds – Life insurance is considered something you buy. It is not taxed to the beneficiary.
  7. Child Support – Child support is taxable income to the payer, not the person receiving it.
  8. Alimony from agreements dated Jan 1st 2019 and later –  Starting in 2019, spousal support is treated like child support. If you were ordered to pay spousal support prior to 2019, the old rules still apply and it is still taxable to the receiver. 
  9. Government benefits –  This includes EBT, WIC, TEA, and TANF. It also includes 2020 relief such as the EIDL grant and PPP forgiven loans.
  10. Insurance or legal settlements for damage to your property AND
  11.  Insurance or legal settlements for bodily injury or pain and suffering. However any awards based on punitive damages or lost income or wages are definitely taxable.
  12. Most scholarships and grants to go to school. Check with your school or tax pro on scholarships and fellowships.
  13. Refundable tax credits like EIC and Child Tax Credit.  2020 relief such as Economic Impact (Stimulus) Payments; payroll tax refunds for sick pay and the Payroll Retention Credit; and state and local grants funded with federal money are also excluded tax-tree income.
  14. Most profits from selling your home – When selling your home, you can exclude up to $250,000 of the profits.
  15. Credit card rewards/ miles/ points or similar cash-back programs. Points are considered a discount or coupon and not currently taxed.

Check the rules on Tax-Free Income

Even though these are generally excluded from income, the IRS has specific definitions for each of the above so be sure to check with your tax pro.

Note: Social Security and unemployment are NOT on the above list and ARE often taxable.

Always check the rules or ask a tax expert before you decide if something isn’t taxable.

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