As you probably are painfully aware, the majority of sources of your income are taxable by the IRS. Whether you earn it through a salary, hourly wages, tips, commissions, rent from a property that you lease, or via interest and dividends on your investments, Uncle Sam is going to demand his fair share.
Even barter income is taxable. Say you exchange your hair-cutting services for lawn-cutting services. Seems like a fair trade, right? According to the IRS, you must pay tax on the fair market value of the mowing services you receive.
What if you decide to do something really unsavory and embezzle funds from your boss or your book club? Believe it or not, that income is also taxable. In fact, the IRS specifically spells out that kickbacks and embezzlement proceeds are subject to income tax.
Is there any way an income-earning taxpayer can catch a break? As a matter of fact, quite a few kinds of income are deemed tax-free. Here are 18 types of income the IRS can’t touch.
- The government will demand income tax be paid on a variety of ordinary income sources, from wages and salaries to interest and dividends.
- Certain forms of income, however, may be tax-exempt, subject to certain limits and qualifications.
- Examples of nontaxable sources of income include veterans' benefits and life insurance payouts.
1. Veterans' Benefits
Benefits paid to veterans and their families are non-taxable. These include:
- Education, training, and subsistence allowances
- Disability compensation and pension payments for disabilities
- Grants for homes designed for wheelchair living
- Grants for motor vehicles for veterans who lose their sight or use of their limbs
- Insurance proceeds and dividends paid either to veterans or to their beneficiaries
- Interest on insurance dividends left on deposit with the Veterans Administration
- Benefits under a dependent-care assistance program
- The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001
- Payments made under the compensated work therapy program
- Any bonus payment by a state or political subdivision because of service in a combat zone
2. Child Support Payments
Any money you receive for child support is not taxable.
3. Welfare Benefits
Welfare payments such as those provided by SNAP or TANF are not taxed by the IRS.
4. Workers' Compensation
If you receive workers’ compensation for an employment-related illness or injury, this income is exempt from taxes provided that payments are made under a workers’ compensation act.
5. Foster Care Payments
If you are a foster parent receiving foster payments from a child placement agency or the state or local government, this income is not taxable.
6. Casualty Insurance
If you have an insurance claim because of a car accident or house fire, casualty insurance payments you receive are tax-free unless the payments exceed your actual loss.
7. Payments From a State Crime Victims' Fund
If you receive payments from a state fund for the victims of crime, this is also nontaxable income.
If you receive an inheritance from a deceased friend, relative, or even an acquaintance, you often do not have to pay federal taxes on it. That’s because the estate of the deceased pays all the taxes, if any are due, before you receive the inheritance. The estate tax will depend on the value of the taxable estate. Some states do impose state taxes on inheritances, so check.
9. Disaster Relief Grants
Under the Disaster Relief and Emergency Assistance Act, if you receive post-disaster relief grant payments and use the income to meet your necessary expenses or needs for medical, dental, housing, personal property, transportation, or funeral expenses, this income is exempt from taxes.
10. Black Lung Disease Benefits
Any federal black lung benefit payments you receive through the Division of Coal Mine Workers’ Compensation (DCMWC) are considered nontaxable income.
11. Supplemental Security Income
This U.S. government program provides monthly benefits to low-income people who are either 65 or older, blind, or disabled. The Social Security Administration administers the Supplemental Security Income (SSI) program, but the monies for it come from U.S. Treasury general funds, not the Social Security trust fund. SSI payments are not taxable.
12. Interest on Municipal Bonds
Interest on certain municipal bonds issued by states, cities, counties, and other government entities to finance their operations are generally exempt from federal income tax. They may also be exempt from state and local taxes, depending on whether you reside where the bond was issued, making them double-, or potentially "triple-exempt."
13. Compensatory Damages Awarded for Physical Injury or Sickness
Damages awarded for physical injury, physical illness, or emotional distress due to a physical injury or sickness are typically exempt from taxes.
14. Gambling Income (If It Offsets Losses)
Gambling income is non-taxable only if your total losses are greater than your total winnings for the tax year. If, on the other hand, your gambling income exceeds your losses, that income is taxable. You need to report separately on your tax forms winnings as income—and can deduct losses up to the amount of your winnings, if you itemize your deductions, as "other itemized deductions."
If you receive a monetary gift from a relative or friend, you do not owe taxes on that income. If the gift is more than $15,000 for 2020 or 2021, the giver may owe gift tax, but you do not.
16. Combat Pay
The military income you receive while stationed in a combat zone is usually not taxable.
17. Vacation Rental Income (Limited)
If you rent your personal home for less than 15 days during the tax year, then this income does not need to be reported to the IRS.
18. Life Insurance Death Benefits
The Bottom Line
While it often seems as if the IRS manages to take a bite out of every type of income you could possibly earn, there are quite a few exceptions to that rule. Before you assume any income is taxable or nontaxable, double-check with a tax professional or visit the IRS website.