When it comes to taxes, most people assume that all income is taxable. However, there are several types of untaxed income that the IRS does not require you to report. Understanding these sources of tax-free income can help you maximize your earnings while staying compliant with tax laws. In this article, we’ll explore 10 types of untaxed income in the US that you may be able to take advantage of.
1. Gifts & Inheritances
If you receive money or property as a gift or inheritance, you typically do not have to pay taxes on it. However, large gifts may be subject to the gift tax, which the giver, not the recipient, pays. As of 2024, individuals can give up to $18,000 per year per recipient without triggering the tax. For example, if a parent gives their child $15,000 to help with a down payment on a house, that amount is tax-free for the recipient.
2. Life Insurance Payouts
Life insurance benefits received by a beneficiary are not taxable. However, if the insurance company offers a settlement where you earn interest on the payout, that interest is taxable. For instance, if a policy pays out $500,000 to a beneficiary, they will not owe taxes unless they choose to keep the money in an interest-bearing account.
3. Municipal Bond Interest
Investing in municipal bonds can be a great way to earn tax-free income. The interest earned from these bonds is exempt from federal taxes and may also be tax-free if you live in the issuing state. For example, if you invest in municipal bonds from your home state, your earnings may be completely tax-free.
4. Scholarships & Grants
If you receive a scholarship or grant, the portion used for tuition, books, and educational expenses is not taxable. However, any amount used for room and board or personal expenses is considered taxable income. For example, a student receiving a $10,000 scholarship for tuition does not owe taxes, but if $2,000 of that is allocated for housing, that portion is taxable.
5. Worker’s Compensation
Benefits received under a worker’s compensation program for job-related injuries or illnesses are not taxable at the federal level. This includes payments for medical expenses and lost wages. For example, if an employee is injured on the job and receives $20,000 in worker’s compensation benefits, that amount is tax-free.
6. Health Savings Account (HSA) Withdrawals
Contributions to an HSA are tax-deductible, grow tax-free, and can be withdrawn tax-free if used for qualified medical expenses. This provides a powerful way to save on healthcare costs. For example, if you have $5,000 in an HSA and use it for surgery or prescriptions, you won’t pay any taxes on the withdrawal.
7. Disability Insurance Benefits
If you paid for disability insurance with after-tax dollars, the benefits you receive are tax-free. However, if your employer paid the premiums, any benefits you receive would be taxable. For instance, if you receive $2,500 monthly from a personal disability policy, you won’t owe taxes on that income.
8. Roth IRA Withdrawals
A Roth IRA allows for tax-free withdrawals of both contributions and earnings, as long as you meet the requirements (you must be at least 59½ years old, and the account must be at least 5 years old). For example, if you withdraw $50,000 from a Roth IRA in retirement, you won’t pay any taxes as long as you meet the conditions.
9. Dependent Care Benefits
Employer-provided dependent care assistance of up to $5,000 annually is not taxable. This can be a great way for working parents to save on childcare costs. So, say your employer offers a dependent care FSA, you can use pre-tax dollars to pay for daycare or after-school programs.
10. Veterans’ Benefits
Payments made to veterans, including disability compensation and pension benefits, are tax-free. Other untaxed benefits for veterans may include housing allowances and certain educational benefits. For instance, a veteran receiving a $1,500 monthly disability payment will not owe taxes on that income.
Understanding different types of untaxed income can help you keep more money in your pocket while ensuring you remain compliant with IRS regulations. If you’re unsure whether a specific type of income is taxable, consulting with a CPA or tax professional can help you make the most of these tax-free opportunities.
Would you like more personalized tax-saving strategies? Contact Zaouk CPA today to learn how we can help you optimize your finances and tax return, ensuring you stay tax compliant.
