Navigating tax season requires a keen understanding of which types of income are taxable and which are not. In 2024, certain types of income are treated differently under U.S. tax laws, making them exempt from federal taxes.
Here are the types of non-taxable income and useful tips for each.
1. Gifts and Inheritances
Gifts and inheritances are often a sigh of relief as they are not subject to federal income taxes. The IRS allows individuals to give up to $17,000 per recipient annually without incurring any gift taxes. Talk to a tax expert to ensure the IRS doesn’t tax big gifts or inheritances you get.
If you receive less than $12.92 million in inheritances in your lifetime, you won’t owe federal taxes on them. Check with a tax pro to handle gifts and inheritances over these limits correctly.
2. Life Insurance Payouts
Life insurance proceeds received upon the death of an insured person are not taxable for the beneficiary, providing a significant source of income without tax burden. The tax-exempt status applies to all payout sizes, ensuring you retain the full benefit of the payout.
Beneficiaries should verify life insurance policy ownership to maximize these benefits without complications. The policy must not be owned by the insured at the time of death to avoid subjecting the proceeds to estate tax.
3. Municipal Bond Interest
Municipal bond interest remains an attractive income source for investors. If the bonds are issued in the investor’s state of residence, they are exempt from federal taxes and often from state and local taxes.
Municipal bonds finance local projects such as schools, highways, and hospitals. They can be a win-win for investors in high tax brackets who seek tax-free income and want to support public initiatives. Before you invest, assess the credit quality of the issuing municipality and consider the transaction costs and potential alternative minimum tax implications.
4. Health Savings Account (HSA) Distributions
Distributions from HSAs for qualified medical expenses continue to be a popular way to spend tax-free on health care. Contributing to an HSA offers a double tax advantage: deductions when contributions are made and tax-free withdrawals for qualified expenses.
It’s essential to review the list of IRS-qualified medical expenses and retain receipts as proof of the health expenditures. Doing so ensures compliance and the proper use of HSA funds.
5. Roth IRA Withdrawals
In retirement, withdrawals from a Roth IRA are tax-free, provided certain conditions are met, such as holding the account for at least five years and reaching 59 ½ years. It makes Roth IRAs a potent tool for retirement planning, granting retirees the flexibility to manage their taxable income.
Contributions to a Roth IRA are made with after-tax dollars. While there’s no upfront tax deduction, like with a traditional IRA, the long-term benefits can be substantial.
6. Child Support Payments
Payments made for child support are not taxable to the recipient nor deductible by the payer. This guarantees that the funds go directly to the child’s needs without tax complications.
Recipients should maintain accurate records and documentation of all child support payments. While these payments don’t need to be reported on tax returns (unlike alimony in some cases), it’s still important to record them if you need to refer back to them.
7. Scholarships and Fellowships
Scholarships and fellowships for tuition and direct educational expenses aren’t considered taxable income. To retain this exemption, scholarship recipients must use the funds for qualifying expenses like tuition, not incidental expenses like room and board.
Recipients should diligently maintain records that state how the funds were used. Doing so prevents their scholarship from being classified as taxable income.
8. Welfare Benefits
Government-provided welfare benefits like food stamps or housing assistance do not count as taxable income. To support those in need, recipients must report any changes in their financial circumstances to the relevant agencies to ensure continued eligibility.
Welfare benefits aim to provide immediate financial aid and typically don’t have tax implications. However, unemployment benefits are generally taxable, as they are considered income replacement.
9. Gifts from Foreign Individuals
Gifts bestowed by a foreign person to U.S. citizens out of friendship or as an expression of courtesy are not taxed. However, if the personal gift’s value exceeds $100,000 in a tax year, you must disclose it to the IRS.
If the gift comes from a corporation, you need to report it when it exceeds $18,567 for 2023. If that is the case, it may be wise to consult a tax professional to help you fill out the appropriate forms.
10. Compensatory Damages for Physical Injury or Sickness
If you receive damages as compensation for personal physical injuries or sickness, this amount is not taxable. The exemption from taxes applies specifically to compensatory damages, which include costs for medical care and compensation for the injury.
While settlement money is tax-free, punitive damages meant to punish the other party are taxable. To avoid unexpected tax bills and ensure you’re not taxed on exempt portions, seek guidance from a professional. They can help structure your settlement to maximize your take-home amount.
11. Foreign Earned Income Exclusion
Under the Foreign Earned Income Exclusion, Americans working abroad can shield a portion of their income from U.S. taxation. To qualify, expats must either be bona fide residents in a foreign country for an entire tax year or have been physically present in another country for at least 330 full days out of the last 12 months.
Afterward, expats may claim the exclusion on their tax returns. This can be a significant tax benefit, but it requires maintaining specific records and meeting residency requirements.
12. Veterans’ Benefits
Benefits received by veterans for education, training, or subsistence are not taxable. Veterans and their families should carefully examine all available benefits.
For instance, many are tax-free, which means they provide financial relief without increasing tax liability. Consult with a tax advisor who specializes in veterans’ benefits to grasp the full scope of these provisions.
13. Qualified Public Safety Officers’ Insurance Premiums
Certain insurance premiums paid by retired public safety officers are excluded from taxable income, reducing their tax liability during retirement.
These tax benefits apply to specific insurance plans and premiums deducted from retirement plans. Officers can exclude up to $3,000 annually. If you are eligible, remember to coordinate these benefits with your retirement plans.
14. Adoption Assistance Under Employer Programs
Employer-provided adoption assistance, including reimbursement of adoption expenses, can be excluded from taxable income. To maximize this benefit, employees should be aware of the federal adoption tax credit limits.
It’s also important to know how employer assistance interacts with this credit. Adhere to IRS guidelines to exclude these benefits from taxable income and avoid any possible tax repercussions.
15. Energy Generation Incentives
Homeowners can benefit from certain tax-free state and federal incentives if they install renewable energy systems such as solar panels or wind turbines.
These incentives are designed to offset the costs of systems that generate clean energy. Homeowners should research the available credits and rebates to understand their eligibility and the tax implications.
16. State or Local Tax Refunds
State or local tax refunds are tax-exempt for individuals opting for the standard deduction instead of itemizing deductions. Those who choose the standard deduction circumvent the need to declare refunds as income the following year.
Taxpayers should analyze which option is more beneficial for them each tax year. All deductions and incomes should be taken into account when doing so.
17. Disability Insurance Payments
When premiums for disability insurance are paid with after-tax dollars, any benefit payments received due to disability are not taxed. Be sure to review the taxation of your insurance benefits, as they are taxed when your employer pays 100%.
It’s crucial to understand how premium payments affect tax liability on benefits received. It lets you make informed decisions about your insurance purchases.
18. Certain Types of Education Assistance
Education assistance benefits provided by employers, such as tuition reimbursement, are not taxable up to a certain limit ($5,250 for 2023). If you are a beneficiary of these programs, stay current on any policy changes.
The IRS also limits the ability to exclude such assistance from taxable income, so be mindful. It can enhance the value of educational benefits provided by employers.
19. Home Sale Profits (Within Limits)
Profits from the sale of a personal residence are excluded from taxable income up to $250,000 for single filers. The amount is up to $500,000 for married couples filing jointly if they have lived in the home for at least two of the last five years.
Homeowners should know these limits and maintain records of improvements and sale-related expenses. These records can add to the home’s cost basis and potentially increase the non-taxable profit.
20. Income from Certain Partnerships, S Corporations, and Trusts
Income received from certain partnerships, S corporations, and trusts may pass through to the individual. These pass-through transactions happen without incurring additional federal taxes at the individual level.
Recipients should consult tax professionals to comply with IRS rules and understand pass-through taxation and state-level tax implications.
Self-Employed Tax Deductions
Self-employed people like their independence and ability to work when and where they want. But running a business still requires paying taxes. Here are ten essential tax deductions that self-employed people need to know. If you don’t take advantage of these, you may be paying more taxes than you should.