Generally speaking, income you earn from your job or business is fully taxable at the federal level and, where applicable, at the state level.
However, some types of investment income can be nontaxable, which can significantly enhance your returns. Certain other non-wage payments you may receive, such as some types of insurance or other benefit payouts, also might be tax-free.
Municipal bonds are probably the most common type of nontaxable investment. Municipal bonds pay interest that is free from federal tax and also tax-exempt for residents of the state issuing the bond. This makes them particularly attractive for investors in the highest tax brackets, as it boosts their net yield.
For example, if you buy a municipal bond paying a 4% interest rate and you’re in the 37% tax bracket, your effective taxable yield is a whopping 6.35% — and that doesn’t take into account any state tax benefit you may receive as well.
Long-Term Capital Gains
Long-term capital gains — those held for longer than one year — are taxed at 15% for most investors. This is a huge advantage over short-term capital gains rates, which are the same as your ordinary income tax rate and can be as high as 37% in 2023.
But, if you’re single with a taxable income of $40,400 or less — or married filing jointly with income of $80,800 or less — your long-term capital gains tax rate drops to 0%. In other words, if you can keep your income under the annual limit, you won’t have to worry about paying any capital gains tax at all on your long-term winners.
If you profit from the sale of your home, it’s considered a capital gain, the same as selling a winning stock. However, there’s a generous provision in the tax code that exempts gains on the sale of a primary residence of up to $250,000 for singles (or $500,000 for joint filers).
The only provision is that you must have used the home as your primary residence for at least two of the prior five years.
Social Security Retirement Benefits
For most retirees, Social Security benefits are taxable. However, if you earn less than $25,000 as a single filer or $32,000 as a joint filer, your Social Security benefits are completely tax-free.
Even if you earn more, at least a portion of your Social Security benefits are likely not taxable. Specifically, single filers with incomes between $25,000 and $34,000 may have to pay tax on just up to 50% of their benefits, while those earning more than $34,000 might face tax on up to 85% of their benefits. Those earning limits are $32,000 to $44,000 and $44,000 or more for joint filers, respectively.
If you pay the entire cost of a disability insurance plan, even if it is offered through your employer, the payments you receive are nontaxable. However, if your employer pays the premiums for your policy, then the money you receive is fully taxable. If you and your employer share the cost of your policy, then only the portion attributed to your share of the premiums is considered nontaxable.
Generally speaking, payments you receive from a worker’s compensation policy are considered nontaxable. However, there are some situations in which your worker’s comp can be considered taxable income. Specifically, if your worker’s compensation payments reduce your Social Security or railroad retirement benefits, a portion of your worker’s comp payments can be considered taxable. Workers comp also can become taxable if you return to work while receiving payments.
The Bottom Line
Money you earn from an employer or your own business is generally fully taxable. To generate nontaxable income, you’ll generally have to make an investment of some type. Certain types of insurance payouts may also be tax-free. If you have any doubt as to whether income you receive is taxable, be sure to consult with a tax advisor.
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