Although I do my civic duty and file my taxes every year, the American tax code is one of the most complex in the world. So, it feels like I am always learning something new. As my finances become more diverse, I have also discovered that certain sources of income may be exempt from your tax obligations. Do you know what type of income the IRS can’t tax?
16 Types of Income the IRS Can’t Tax
If you pay attention to your pay stubs, then you already know how much money the federal government takes from your paycheck. And if you are self-employed like me, then you are probably aware and have already sent payments for your tax obligations. However, certain sources of income are exempt. Here are 16 types of income the IRS can’t tax.
Adoption Assistance
If you have considered adoption or are currently going through the process, you should look into adoption assistance. Not only does it offer financial relief, but the adoption fees, court costs, and travel qualify as tax-free income. However, there are limits. For 2022, the maximum amount of assistance is limited to $14,890 per child.
Alimony
Divorce can be a messy and confusing process, especially when it comes to finances. And it has gotten more complicated since there has been recent legislation that has changed to rules on taxation under the Tax Cuts and Jobs Act.
As it stands, those receiving alimony don’t have to pay taxes on this money. However, if you finalized your divorce after January 1, 2019, anyone responsible for paying alimony can’t claim this deduction. If you don’t understand all the implications of the new rules, you can get more information from Publication 504 or a tax professional to learn how it affects you.
Child Support
Similar to alimony payment, child support is another source of funding that the IRS can’t tax. In fact, it isn’t even considered income by the federal government. So, you don’t need to claim this information on any tax forms.
Credit Card Rewards
Many credit cards have rewards programs for their members which include cash back. But, the IRS doesn’t consider it taxable income. Instead, it treats them like a rebate. Since you had to purchase something and accrue rewards to receive the rewards, you won’t have to pay taxes on them.
Disability Insurance
Disability insurance is another area that has different rules depending on who’s paying for it. If your employer is the one who pays the premiums, then it will be taxable income. However, if you have a private disability policy and pay for it with your funds, then you don’t need to claim these payments on your tax return.
Disaster Assistance
When disasters strike, many federal agencies provide money for disaster relief through the Federal Emergency Management Agency. Fortunately, these payments aren’t taxable. As long as the funds were not paid through insurance or other reimbursement programs, they should be tax-exempt.
Education Assistance
Another great perk that many companies offer their employees is education assistance. They are allowed to offer up to $5,250 per year. Although some set lower thresholds, any money that they provide for educational costs isn’t taxable. Therefore, it shouldn’t be calculated as part of your compensation, wages, or tips.
Financial Gifts
Financial gifts are another source of income that the IRS can’t tax. But keep in mind, there are limits to this exemption. The maximum amount that can qualify for gift tax exclusion is $16,000 for 2022. However, it will increase to $17,000 in 2023. If the gift is below this amount, neither person has to pay taxes unless it is a gift that could generate money down the line such as stocks, bonds, etc.
Foster Care
Any funding you get from the state or eligible sources to care for foster children qualifies as child support. Since the IRS treats it the same way, it can’t be taxed by the IRS. However, there are some circumstances, such as the maintenance of areas utilized for emergency foster care, which fall under different rules and tax codes.
Health Savings Account
Health Savings Accounts are a type of trust through insurance companies, banks, and other approved entities to cover medical expenses. One of the best perks of an HSA is the tax-free status. Employer contributions are also not counted as part of your gross income.
But like all tax-advantaged accounts, there are rules. The limits for 2022 are $3,650 for a single filer and $7,300 for family coverage. But, those over 55 can put in an additional $1,000 annually.
Home Sales Capital Gains
Capital gains are one way that the federal government ensures that it always gets its cut of profits, even when selling your home. However, if you owned and utilized it as your primary residence for two of the last five years, you can reduce the amount you owe. If you meet eligibility requirements, you can exclude a portion from the total reported amount. The exempted amount is $250,000 for individuals and $500,000 for joint filers.
Inheritance
Generally speaking, you don’t pay taxes on your inheritance. But again, there are always exceptions to the rules. Inheritance taxes usually only affect large estates. So, you won’t have to worry about paying these taxes unless it’s worth more than $12 million.
Life Insurance Payouts
Many people purchase life insurance to ensure support for their families and loved ones. Therefore, beneficiaries do not need to report life insurance payouts as income.
But keep in mind, you should report the interest earned and pay taxes on it. You will also pay tax for anything above the cost of the policy when you cash out early. Although, you may avoid these penalties if you are taking withdrawals due to terminal illness or long-term healthcare expenses.
Income from Roth IRA
I started my retirement planning with a Roth IRA because it offers so many advantages to taxpayers. For example, it isn’t taxable income since you fund it with after-tax dollars. The only instance you may have to pay taxes is if you choose to take early withdrawals.
Scholarships
As I help my niece through the college application process, I’m learning all kinds of things about education assistance. She was fortunate enough to receive several types of scholarships and grants. Although we thought her parents may have to pay taxes on it, we found out that as long as it pays for tuition, enrollment fees, and course-related educational expenses, it isn’t taxable income.
Workers’ Compensation
Last but not least, workers’ compensation is another source of income the IRS can’t tax. The only way it could affect your tax burden is through your retirement plan. Those who retire early due to an illness or injury may receive reduced Social Security benefits.
Food for Thought
Even if you are not currently receiving any of these types of income, things could change in the future. Therefore, it’s always smart to learn more about your tax responsibilities to stay ahead of your long-term financial planning. Learning about these things now could help optimize your investment strategy and keep more of your hard-earned income.
What else do you think everyone should know about the American tax codes? Share your thoughts below!
Read More
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Jenny Smedra is an avid world traveler, ESL teacher, former archaeologist, and freelance writer. Choosing a life abroad had strengthened her commitment to finding ways to bring people together across language and cultural barriers. While most of her time is dedicated to either working with children, she also enjoys good friends, good food, and new adventures.