9 Types of Income You Might Not Know Can Be Nontaxable

When it comes to paying taxes, most people are aware that they need to report and pay taxes on their income. However, not all types of income are taxable, and many people might not be aware of the different income sources that fall under this category. Understanding what types of income are nontaxable can help you reduce your tax burden and keep more of your hard-earned money.

We will explore some of the less commonly known types of income that can at least sometimes be nontaxable. From inheritance and gifts to disability and life insurance payments, there are a variety of income sources that you may not know are exempt from taxes. Read on to learn more about these types of income and how they can impact your tax liability.

Inheritances such as cash, investments and property are not subject to income tax under Federal Tax regulations. However, any interest or income earned from these inherited assets may be taxable unless the source of such interest or income is tax-exempt. “For example, business profit from inherited businesses is taxable,” said senior tax accountant Wayne Bechtol. 

The IRS defines a gift as any transfer of property or money to another individual or entity, where the giver, or donor, does not receive anything of equal value in return. The gift may be given to anyone, including family members, friends or strangers. Additionally, the gift can be in the form of cash, property or other assets. Generally speaking, gifts from family and friends are not taxable. However, that’s not always the case. “There are exceptions to this rule, such as the donor having to pay a gift tax if the amount of the gift exceeds a certain threshold, $15,000 as of 2022, but for the vast majority of small gifts, no taxes are due,” Michael Hammelburger, CEO of The Bottom Line Group, told GOBankingRates. 

The IRS requires that gifts above a certain value, known as the gift tax annual exclusion, must be reported on a gift tax return. It’s important to note that the gift tax is paid by the donor, not the recipient of the gift. And keep in mind that the exemption applies only to gifts received from individuals, not businesses or organizations. 

Alimony payments have become a common consequence of divorces in the U.S. These are periodic payments awarded by a court order to support the living expenses of a divorced spouse. According to Bechtol, following the legislation of the Tax Cuts and Jobs Act of 2017, alimony payments associated with divorce agreements dated Jan. 1, 2019, and later are not taxable for the recipient. As a result, the beneficiary does not need to report alimony as taxable income, but it must be reported on tax returns. The payer cannot claim a deduction for alimony payments.

Child support payments received by a parent from an ex-spouse or partner are not taxable income and need not be reported on the tax return. Moreover, child support payments cannot be deducted as charitable contributions or any other type of deduction on the tax return. The reason child support payments are not subject to income tax is that they are intended to benefit the child rather than the recipient.

In the U.S., municipal bond interest is a type of income that is frequently exempt from taxation. Municipal bonds are issued by local and state governments to finance projects such as hospitals, schools and infrastructure.

Roth retirement accounts are financed with money that has already been taxed, implying that the withdrawals you make from these accounts during your retirement phase are typically not subject to taxation.

Social Security benefits can be a type of income that is potentially exempt from taxation, depending on your income level. If you earn below a certain threshold, your Social Security benefits may not be subject to any taxes. However, if your income surpasses this threshold, only a portion of your benefits may be taxable.

When it comes to employer-provided insurance, accidents, illness and long-term coverage are typically not taxed. That’s not all — payments made by your employer to healthcare spending accounts like HRAs and HSAs are also tax-free. But, here’s the deal with disability benefits — if your employer covers the insurance costs, then any disability payments you receive might be taxed.

There are a few other types of income that might be free from federal income tax, such as life insurance payouts, certain types of disability income, workers’ compensation and veterans’ benefits. It’s worth noting that some types of income could still be taxed at the state or local level, or in specific situations. Here’s some more good news — cash rebates you receive from retailers, dealers, or manufacturers are typically not taxed. Additionally, any money reimbursed from qualifying adoptions is usually nontaxable too.

As you’ve seen, there are numerous types of income that can be exempt from taxes. However, it’s always a good idea to seek advice from a tax expert to ensure that you’re aware of what is taxable and what isn’t.