Most income earned by U.S. citizens is subject to federal and sometimes also state taxation. However, not all types of income are taxable. If you’re reading this article, you’re like interested in reducing your taxable income. Our free guide 5 Tax Hacks for Investors gives best practices for effective tax management.
Certain kinds of income are free from taxation — or in other words, this income is nontaxable. Following are some of the most common forms of tax-free income.
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1. Financial Gifts
You can give away up to $15,000 per person each year to whoever you like without having to pay gift tax. Together, you and your spouse can give away up to $30,000 per person gift-tax free. Any amounts you give away above these exclusion amounts could be subject to a gift tax of between 18% and 40% in 2021, depending on the value of the gift in excess of these exclusions.
A few other types of gifts are also nontaxable, including political donations, gifts to qualified charities and tuition or medical expenses paid on behalf of someone else. Financial gifts from employers (like gift cards), however, may be taxable as fringe benefits, depending on their value.
2. Educational and Adoption Assistance from Your Employer
If the company you work for provides you with educational assistance — such as paying for you to attend night school to pursue a graduate or undergraduate degree — you can exclude up to $5,250 of this assistance from your gross income. Up to $14,440 in employer-provided adoption assistance is also considered to be nontaxable income. The exact amount of your income exclusion for adoption assistance will depend on your modified adjusted gross income.
3. Employer-provided Meals and Lodging
Though these aren’t technically income, if your employer provides you with any meals or lodging, you don’t have to include their value in your taxable income. To qualify for this tax-preferential treatment, the meals and lodging must be furnished on your employer’s premises for the convenience of the employer.
4. Proceeds from a Home Sale
You can exclude up to $250,000 from the sale of your home from capital gains taxes, or $500,000 if you’re married and file a joint tax return. To qualify for this exclusion, you must have owned the home and lived in it as your principal residence for at least two of the past five years.
5. Insurance Provided by Your Employer
Several different kinds of employer-provided insurance are nontaxable. This includes accident and health insurance, long-term care insurance, coverage and reimbursement for medical care provided through a health reimbursement arrangement (HRA), and up to $50,000 of employer-provided group term life insurance. If your employer provides more than $50,000 of such insurance, the cost of the excess will be taxable to you.
6. Health Savings Accounts (HSAs)
HSA distributions are nontaxable as long as the money is used to pay for qualified healthcare expenses. A wide range of medical expenses meet this criteria including copays for regular doctor’s office visits, surgery (except cosmetic surgery), acupuncture and chiropractic treatments, dental work (including orthodontics), eyeglasses, drug prescriptions and over-the-counter medications, laboratory fees, physical therapy, and vaccines.
Read More: HSA vs FSA: Tax Benefits of Health Savings
7. Disability and Life Insurance Payouts
Benefits you receive from a private disability policy you own are nontaxable if you paid for the policy with after-tax dollars. However, these benefits will be taxable if they’re paid from an employer-provided disability policy for which your employer paid the premiums. Any benefits you receive from an employer-provided supplemental disability insurance policy you paid for with after-tax dollars are also nontaxable.
Also, if you are the beneficiary of a life insurance policy, these benefits generally are nontaxable. There are a few exceptions, though, such as any interest you may receive that’s associated with the life insurance payout.
8. Worker’s Compensation Benefits
If you receive benefits under federal or state compensation law for a work-related injury or illness, this money is nontaxable. However, if part of these benefits reduce your Social Security or railroad retirement benefits, this part could be taxable. And if you return to work on light duty, the income you earn could also be taxable.
If you receive an inheritance from a relative, this income will generally be nontaxable to you. However, depending on the type of assets you have inherited, some income types such as retirement account withdrawals are taxable income to you. The following six states have a state income tax on receiving inheritances: Kentucky, Pennsylvania, Iowa, New Jersey, Nebraska, and Maryland.
10. Municipal Bond Interest
Municipal (or muni) bonds are one of the few types of bonds that offers nontaxable income to investors. These bonds are issued by state and local government entities. In addition to tax-free income at the federal level, muni bonds are also tax-free at the state and local levels for residents of the state in which the bond was issued. The tax exemption applies regardless of whether you purchase individual municipal bonds or invest in muni bonds through a bond fund or ETF.
Muni bonds generally earn less than most other types of bonds. However, these tax benefits could result in a higher after-tax return on muni bonds, depending on your tax bracket.
11. Income from a Roth Retirement Account
One of the biggest benefits of Roth IRAs, 401k plans and 403(b)s is the fact that they offer nontaxable income. In other words, you can withdraw money from your account tax-free after you retire. This is in contrast to traditional IRAs, 401k plans and 403(b)s that are taxable even in retirement, though they do offer tax-deferral.
Certain rules must be followed to qualify for these tax-free withdrawals in retirement. For example, you must be over age 59½ when taking the withdrawals and the withdrawals must be taken at least five years after the account was established.
Read More: Roth 401k vs. Roth IRA – The Key Differences
12. Wage and Salary Income for State Tax Purposes in Some States
Note that there are nine states that do not levy state income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. (New Hampshire does levy tax on interest income and dividends, but not on salaries and wages.) So wage and salary income is free from state, but not federal, income tax if you live in one of these states.
Next Steps for You
With some planning, you can boost your tax-free income. Here are a few follow up suggestions for you.
- Consult with a tax professional for advice and guidance in your specific situation
- Contribute significant amounts to retirement savings plans
- Consider other ways to reduce your taxable income for a $0 tax bill
As you maximize your tax-free income, you can also stay on top of your finances year round with free, online financial tools like those offered by Personal Capital. Millions of people use this powerful technology to see all of their financial accounts in one place in order to manage their money and plan for long-term goals.
Personal Capital compensates Brian E. Leyde (“Author”) for providing the content contained in this blog post. The information and content provided herein is general in nature and is for informational purposes only. Individuals should contact their own professional tax advisors or other professionals to help answer questions about specific situations or needs prior to taking action based on this information. Tax laws and authorities are subject to change, either prospectively or retroactively, and any subsequent change could have a material impact on your situation.