List of twelve types of income that are exempt from taxes – both under federal tax law (Internal Revenue Code ) and state tax laws should always be checked while filing tax return. Tax exempt means an income or transactions that are not considered taxable income under the Federal tax law .Please note that these income may be taxed by some states , but majority of states have tax exempt the income. We have included information about states that tax these income .
Table of Contents
Video : Income Exempt from Taxes
1.Interest received on the municipal bond is exempt from taxes
- As per section 103 of the Internal Revenue Code (IRC), interest income earned from bonds issued by state and local governments is not taxed under federal law and may also be exempt from state income tax. However, there are certain exceptions to this general rule, such as for private activity bonds or bonds issued for certain purposes.
- Here is a list where interest from bonds is not tax free under IRC.
- Taxable municipal bonds: Some municipal bonds are issued with taxable interest instead of tax-exempt interest. Taxable municipal bonds are subject to federal income tax.
- Private activity bonds: Certain municipal bonds issued for private projects, such as housing developments or airports, are subject to federal income tax.
- Build America Bonds: Build America Bonds (BABs) are taxable municipal bonds issued under the American Recovery and Reinvestment Act of 2009. BABs offer a subsidy to issuers through a federal tax credit or direct payment instead of tax-exempt interest.
- Taxable bond funds: Some mutual and exchange-traded funds (ETFs) invest in taxable bonds, including municipal bonds offering taxable interest.
2.Certain Veterans’ benefits are exempt from taxes
Only certain veterans’ benefits, such as disability compensation and pension payments, are exempt from federal income tax and may also be exempt from most states. The exemption to veterans is guided by Section 104 of the IRC. However, certain states taxes veterans’ benefits of disability compensation and pension payments as well.
3.Life insurance proceeds are exempt from taxes
Section 101(a) of the IRC generally exempts the proceeds from a life insurance policy. However, if the policy was transferred for consideration, part of the proceeds may be subject to federal tax.
4.Gifts and inheritances tax exempt for recipients
Gifts and inheritances are generally not considered taxable income; this exemption is provided under section 102 of the IRC. However, if the gift or inheritance is in the form of property that generates income, such as rental property or stocks, the income may be subject to taxation.
As per section 104(a)(1) of the IRC, payments received as workers’ compensation benefits are generally not taxable. However, if the compensation amounts are for something other than a work-related injury or illness, such as emotional distress or defamation, they may be subject to taxation.
6.Roth IRA distributions after 5 years
Distributions from a Roth IRA are generally tax-free if the account has been open for at least five years and the account owner is at least 59½ years old. This exemption is provided under Section 408A of the IRC. However, if the account has not been open for at least five years or is not qualified, it may be subject to taxation.
7.Child support payments are tax exempt
Child support payments are generally not taxable; this exemption is provided under Section 71(c)(1) of the IRC. However, if the payments are designated as something other than child support, such as alimony or property settlement, they may be subject to taxation.
8.Qualified tuition assistance
Section 127 of the IRC exempts amounts of employer-provided tuition assistance for undergraduate or graduate-level courses, and up to $5,250 may also be exempt from state and local income tax.
9.Qualified retirement plan distributions
Distributions from qualified retirement plans such as 401(k) plans, IRAs, and pension plans are generally taxable as income. However, suppose the distribution is qualified, meaning it meets certain requirements, such as being made after the account holder reaches age 59 ½. In that case, it may be exempt from federal, state, and local income tax. This exemption is provided under various sections of the IRC, such as Section 402(a) for qualified employer plans and Section 408(d) for IRAs.
10.Disability insurance benefits are exempt from taxes
Disability insurance benefits paid to an individual due to a disability may be exempt from federal income tax, and they may also be exempt from state and local income tax. This exemption is provided under Section 105 of the IRC.
11.Certain types of damages
Section 104(a)(2) of the IRC exempts certain damages an individual receives, such as compensatory damages for physical injury or sickness. These damage payments may also be exempt from state and local income tax.
12.Certain types of foreign income are exempt from taxes
Certain types of income earned by U.S. citizens or residents while living and working abroad, such as foreign earned income and housing allowances, may be exempt from federal income tax and states and local income tax. Refer to section 911 of the IRC for.
It is important to note that state and local tax laws may vary and may provide different exemptions or exclusions from income tax. Therefore, before you consider an income as exempt from taxes, consulting with a tax attorney or tax professionals like CPAs for specific guidance on your individual tax situation.
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