12 Top Sources of Nontaxable Income

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12 Top Sources of Nontaxable Income

The majority of your earnings from labor or investments are subject to federal income tax and, in certain cases, state income tax. Certain types of income, however, are free from income tax. Here are 12 facts regarding taxes that every taxpayer should be aware of.

Key Takeaways

  • The majority of your income is likely taxable, but federal and state tax regulations provide for various exemptions.
  • States tax income differently, and some have no income tax at all.
  • Certain investments, such as municipal bond interest and earnings on Roth IRA contributions, may provide tax-free income.

1. Disability Insurance Payments

If your employer paid the premiums for the coverage, your disability benefits are taxable. However, several types of disability compensation are exempt from taxation:

  • Any benefits you get from additional disability insurance bought with your own after-tax cash via your employer.
  • Benefits from a private disability insurance plan bought using after-tax cash.
  • Payments for workers’ compensation.
  • Compensatory (but not punitive) damages for bodily harm or illness, compensation for permanent loss or loss of use of a body part or function, or compensation for permanent disfigurement.
  • A public welfare fund provides disability payments.
  • Disability benefits are available under a no-fault vehicle insurance policy for injuries that result in a loss of income or earning capability.

2. Employer-Provided Insurance

According to the IRS, “the amount of accident or health plan coverage supplied to you by your employer is not included in your income in most situations.” This might be health insurance supplied by your company via a third party (such as Aetna or Blue Cross) or medical coverage and payment given through a health reimbursement agreement (HRA).Long-term care insurance supplied by an employer is likewise not taxed.

Furthermore, an employee does not pay tax on the cost of group term life insurance given by an employer up to $50,000. In other words, if your company pays $250 to provide you with a $50,000 death benefit life insurance policy, you owe no tax on that $250.

However, if your company pays for more than $50,000 in group term life insurance, you must pay tax on the excess coverage. So, if your company spends $283 to provide you with $80,000 in insurance, you’ll owe tax on $33.

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3. Health Savings Accounts (HSAs)

Health savings account (HSA) distributions are not taxed if used for eligible medical costs. You can only contribute to an HSA if you have high-deductible health insurance. You may, however, accept distributions at any moment. Furthermore, if your employer contributes to your HSA, that money is generally tax-free as well.


HSA payouts aren’t taxed if you’re handicapped or 65 or older, even if you don’t utilize the money for eligible medical costs. (L21)

4. Life Insurance Payouts

With a few exceptions, if a loved one dies and leaves you a life insurance payout, this income is normally not taxed. There may also be tax repercussions if you cash in or convert a life insurance policy you possess.

If you obtain accelerated life insurance benefits because you are terminally ill, these payments are normally not taxed. If you get this money in monthly installments as a result of a chronic illness, it may not be taxed if you use it for long-term care.

5. Earned Income in Eight States

States differ in terms of the types of income they tax and the rates at which they tax it. Individual income taxes are not levied in eight states: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. In New Hampshire, only interest and dividend income is taxed, not salaries and wages. The federal government taxes Social Security income, but most states do not.

6. Corporate Income Earned in Six States

According to the Tax Foundation, there are no corporate income taxes in six states: Nevada, Ohio, Texas, Washington, South Dakota, and Wyoming. Nevada, Ohio, Texas, and Washington, on the other hand, tax a corporation’s gross revenues. South Dakota and Wyoming are the only states that do not tax.

7. Sale of a Principal Residence

Individuals and married couples who meet the IRS’s ownership and use tests, which require them to have owned their home for at least five years and lived in it as their primary residence for at least two of the previous five years, can exclude up to $250,000 (for individuals) or $500,000 (for married couples filing jointly) of capital gains when they sell the home from their income.

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8. Financial Gifts

If you get money or other property without offering anything of equivalent worth in return, it is considered a gift, and you will not be taxed on it. Because the lifetime gift tax exemption is $11.7 million in 2021 and $12,060,000 in 2022, the donor normally does not have to. If the gift subsequently generates income (for example, $12,000 in shares), you must pay tax on that income.

9. Inheritances

Inheritances do not qualify as taxable income. Estates of a particular size, however, may be subject to estate taxes, which are paid by the estate itself. The federal estate tax exemption will increase from $11.7 million to $12,060,000 in 2022. Any amount in excess of the exemption is taxed.

10. Municipal Bond Interest

When you invest in bonds, you usually have to pay federal and state taxes on the income you earn from them. Municipal bonds, which are issued by states and other government bodies, are an exception. Their income is normally tax-free at both the federal and state levels, as well as at the local and municipal levels if you reside in the state where the bonds were issued. This tax break applies whether you acquire municipal bonds individually or via a municipal bond fund or ETF. Interest income from US Treasury bills, notes, and bonds is taxed at the federal level but not at the state or municipal levels.


Municipal bonds are often less expensive than other forms of bonds. However, depending on your tax status, they may provide a greater after-tax return than taxable alternatives.

11. Up to $3,000 of Income Offset by Capital Losses

If you sell assets at a loss, you may deduct up to $3,000 from your taxable income each year. Furthermore, capital losses may be carried forward from year to year until the whole loss is neutralized. For example, if you sold assets for a $4,500 loss in 2020, you may deduct $3,000 from your taxable income on your 2020 tax return and the remaining $1,500 on your 2021 tax return.

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12. Roth Retirement Account Income

Qualified retirement accounts, such as 401(k) plans, 403(b) plans, and IRAs, provide a variety of tax benefits, including postponing any tax on investment income and gains until the money is withdrawn. The money you take from a Roth 401(k), Roth 403(b), or Roth IRA is not taxed as long as you follow the Roth regulations.

Which states don’t tax income?

Individual income earned in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming is exempt from state income tax.

What types of gifts are never taxable?

  • Tuition or medical expenditures paid on behalf of someone else
  • Political donations.
  • Donations to charity Charitable contributions, unlike other sorts of presents, are also tax-deductible.

If I give my employee a gift, is it taxable?

Employer financial presents, like as cash or gift cards, are normally considered fringe benefits, not gifts, and are taxed as income.

A rare, low-value present, such as a Christmas fruitcake, is deemed a de minimis benefit and is not taxed.

Where can I get more information on income that’s not taxed?

In its yearly revised Publication 525, the IRS gives thorough information on taxable and nontaxable income.

The Bottom Line

Unless otherwise stated, the IRS’s default view is that all income is taxed. However, you should not assume that all of your income is subject to taxation; the tax legislation offers hundreds of exceptions to this norm. Planning to lawfully take advantage of such exclusions may enable you to live a more fulfilling life.

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