What Is the Income Exclusion Rule?

The income exclusion rule sets aside certain types of income as non-taxable.

There are many types of income that qualify under this rule, such as life insurance death benefit proceeds, child support, welfare, and municipal bond income. Income that is excluded is not reported anywhere on Form 1040.

Key Takeaways

  • Income excluded from the IRS's calculation of your income tax includes life insurance death benefit proceeds, child support, welfare, and municipal bond income.
  • The exclusion rule is generally, if your "income" cannot be used as or to acquire food or shelter, it's not taxable.
  • Municipal bond income is only excludable up to a point.

Understanding the Income Exclusion Rule

Generally, there is no limit to the amount of this type of income that can be received. One exception is municipal bond interest, which may be counted back as an alternative minimum tax preference item.

Income that is excluded from taxation is generally accorded this status as a measure of relief for the recipient (or else as the result of powerful lobbying, as is the case with life insurance).

Income Exclusion Rules and Social Security

For Social Security purposes, not everything an individual receives is considered income. For the most part, if an item received cannot be used as, or to obtain, food or shelter, it will not be considered as income.

For example, if someone pays an individual's medical or automobile repair bills, or offers free medical care, or if the individual receives money from a social services agency that is a repayment of an amount he/she previously spent, that value is not considered income to the individual.

In addition, some items considered to be income are excluded when determining the amount of an individual's benefit. A detailed list of social security income exclusions can be found in section V.B of the SSI Annual Report.

Principal Earned Income Exclusions

  • The first $65 per month plus one-half of the remainder (see general earned income exclusion below)
  • Impairment-related work expenses of the disabled and work expenses of the blind
  • Income set aside or being used to pursue a plan for achieving self-support by a disabled or blind individual
  • The first $30 of infrequent or irregularly received income in a quarter

Principal Unearned Income Exclusions

  • The first $20 per month
  • Income set aside or being used to pursue a plan for achieving self-support by a disabled or blind individual
  • State or locally funded assistance based on need
  • Rent subsidies under HUD programs and the value of food stamps
  • The first $60 of infrequent or irregularly received income in a quarter

Income Exclusions for Employer-Paid Health Insurance

One of the biggest tax exclusions in the U.S. is the exclusion that allows workers who get job-based (or "employer-paid") health insurance coverage not to pay taxes on the value of those policies and employers to deduct the cost as a business expense.

The exclusion costs the Treasury at least $246 billion annually, according to Congress’ Joint Committee on Taxation, dwarfing the second-largest break, the mortgage interest deduction, which costs an estimated $98 billion.