Tax-Free Income and Ways to Save on Taxes
"Little by little does the trick." -Aesop
Whether you work for a paycheck or collect Social Security benefits, there are many sources of income available to you that are completely tax-free. Little by little, they can add up to a lot more money in your pocket.
What is taxable income?
Tax-Free Income Exists? And It's Legal?!
It's true! This page contains updated information about many forms of tax-free income available to the average taxpayer. And it's all legal; tax law does not allow the IRS to tax the income and benefits discussed in the following sections:
What is Tax-Free or Nontaxable Income?
What Are Other Examples of Nontaxable or Tax Free Income?
What is Tax-Free or Nontaxable Income?
Here are the types of income which cannot be taxed:
- Aid to Families with Dependent Children (AFDC)
- Adoption expense reimbursements for qualifying expenses
- Damages for physical injury (other than punitive)
- Death payments
- Dividends of life insurance
- Welfare benefits (including TANF) and food stamps
- Security Income (SSI)
- Accident and/or health Insurance benefits
- Worker's Compensation (and FECA payments)
- Disability Benefits or Disability Pension payments
- Child Support
- Compensatory (but not punitive) damages awarded in court for physical injury or physical sickness
- Gifts, Bequests, and Inheritances up to a certain value
- Dealer/manufacturer cash rebates
- Meals and lodging when required by your job
- Long-term Care Insurance payments
- Qualified scholarships and grants
- Credit card rewards and points (noncash prizes less than $600 or tied to spending habits)
- Frequent flyer miles
- Qualified canceled mortgage debt
- Military Allowances
- Veterans' Benefits
- Medical Savings Account withdrawals
- Life insurance benefits
- Accelerated death benefits
- Reimbursements for theft or casualty loss
- Disaster relief grants
- Up to $102,100 of foreign earned income (for 2017)
- Sickness and Injury Payments
- Federal income tax refunds
- Interest on tax-free securities
- Interest on EE/I bonds redeemed for qualified higher education expenses
- Payments to the beneficiary of a deceased employee
- Relocation payments or payments in lieu of worker’s compensation
- Rental allowance of clergyman
- Social security benefits (if it is your only form of income)
- Temporary Assistance for Needy Families (TANF)
What Are Other Examples of Nontaxable or Tax Free Income?
Please note that the above list is not definitive or all-inclusive. There are other forms of tax-free income available.
Gifts, Bequests, and Inheritances
In general, property you receive as a gift, bequest, or inheritance is not included in your gross income. However, if property you received in this manner later produces income (such as interest, dividends, or rents), that income is taxable. If property is given to a trust and income from it is paid, credited, or distributed to you, that income is taxable.
An inheritance is not reported on your income tax return, but a distribution from an inherited pension or annuity is, and is subject to the same tax as the original owner would have had to pay.
Meals and Lodging
You don't include the value of meals and lodging provided to you and your family by your employer if the following conditions are met:
- The meals are furnished on the business premises of your employer and furnished for the convenience of your employer.
- The lodging is furnished on the business premises of your employer, furnished for the convenience of your employer, and a condition of your employment.
In addition, the amount that qualifies as a de minimis fringe benefit is nontaxable.
Sickness and Injury Payments
Health Plan Payouts
In general, you must report income in any amount you receive for sickness or personal injury through a health or accident plan that is paid for by your employer. If you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income. However, certain payments may not be taxable to you.
Any amount paid to reimburse you for medical expenses you incurred after the plan was established is generally non-taxable income.If you pay the entire cost of a health or accident plan,don't include any amounts you receive from the plan for sickness or personal injury as income. If your plan reimbursed you for medical expenses you deducted in an earlier year, you may have to include some, or all, of the reimbursement.
In most cases, if you are covered by a health or accident insurance plan through a cafeteria plan, and the amount of the insurance premiums was not included in your income, you're not considered to have paid the premiums and you must include any benefits you receive in your income. However, if the amount of the premiums was included in your income, you are considered to have paid the premiums and any benefits you receive are non-taxable.
Are Social Security Benefits Tax-Free?
If Social Security is your only source of income, then it is generally tax-free. If you have other sources of income in addition to Social Security, some of your Social Security Benefits may be taxed.
Find out more about social security and taxes.
Tax-Free Income from Work
Here are several options for tax-free income which may be provided by your employer (some of the amounts are for Tax Year 2016. We will update them to the 2017 amounts once the IRS makes them available).
Your Employer Can Pay for Your Education
Your employer can provide up to $5,250 per year in educational aid when you take undergraduate or graduate courses. Best of all, the school courses don't have to be job-related (your employer might not like it, but the IRS does not care). This is essentially a tax-free pay raise.
Learn about more tax benefits for education.
Your Employer Can Pay for Public Transportation
With gas prices so high, have you considered using public transportation to get to work ... and saving while doing it? Your employer can purchase public transportation fare tickets, passes, or tokens for you to get to and from work. For Tax Year 2016, up to $130 per month may be provided to you tax-free.
Your Employer Can Pay for Your Parking
If you drive to work and pay a fee for parking, your employer can reimburse you up to $250 per month tax free for Tax Year 2016.
Your Employer Can Pay You to Ride a Bicycle to Work
If you primarily use a bicycle to commute to work, you may be reimbursed up to $20 a month, tax-free, for the cost of storage, maintenance, and repairs.
Tax-Free Carpool Income
With gas prices so high, it may be time to consider starting a carpool. As the operator of your own car, any money your passengers pay you for gas or expenses is tax-free income. Generally, if you travel alone you cannot deduct commuting expenses like gas. However, reimbursements from your carpoolers which are used to cover gas, repairs, and other car operating costs are not taxable income. Note that this particular form of tax-free income is paid to you by your passengers and not your employer.
Your Employer Can Pay Your Health Insurance Premiums
If you are not insured through your employer and your HMO insurance premium is $3,360, or $280 a month, your actual cost is much more than that. For this premium, the real cost would be $4,480 (Premium: $3,360 plus $1,120 income tax) per year (25% tax bracket). If you are insured through your employer, both of you will achieve the same benefit. Your income increases and the employer pays less in salary, since the insurance payments are fully deductible. In addition, the payroll taxes on insurance premiums do not apply.
Your Employer Can Pay for Term Life Insurance
Your employer can pay your premiums for term life insurance coverage of up to $50,000. You, the employee, can select a beneficiary of your choice. The employer can deduct the expense and you will have additional tax-free income.
Any veterans' benefits paid under any law, regulation, or administrative practice administered by the Department of Veterans Affairs (VA) are generally non-taxable. These benefits include, but are not limited to:
- Education, training, and subsistence allowances
- Disability compensation and pension payments for disabilities paid either to veterans or their families
- Grants for homes designed for wheelchair living
- Grants for motor vehicles for veterans who lost their sight or the use of their limbs
- Veterans' insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran's endowment policy paid before death
- Interest on insurance dividends left on deposit with the VA
- Benefits under a dependent-care assistance program
- The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001
- Payments made under the compensated work therapy program
- Any bonus payment by a state or political subdivision because of service in a combat zone
Payments you receive as workers' compensation for an occupational sickness or injury are fully tax-exempt if they are paid under a workers' compensation act or statute. The exemption also applies to payments made to your survivors. However, the exemption doesn't apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury.
If part of your workers' compensation reduces your Social Security or equivalent railroad retirement benefits received, that part is considered Social Security (or equivalent railroad retirement) benefits and may be taxable.
If I Have Taxable Income, Are There Ways I Can Reduce My Income?
Yes, you can either claim tax exemptions and standard deductions to reduce your taxable income.
Federal income tax exemptions reduce your taxable income. Each tax exemption is worth $4,050 for Tax Year 2017.
Learn more about income tax exemptions
If you do not itemize deductions, you may subtract the standard deduction from your taxable income when you prepare your tax return.
Learn more about the standard deduction
Are There Types of Income That Could Be Taxable or Non-Taxable?
Some income may be taxable under certain circumstances, but not taxable in other situations. Examples of items that may or may not be included in your taxable income are:
If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Life insurance proceeds, which were paid to you because of the insured person’s death, are generally not taxable unless the policy was turned over to you for a price.
Scholarship or fellowship grant
If you are a candidate for a degree, you can exclude from income amounts you receive as a qualified scholarship or fellowship. Amounts used for room and board do not qualify for the exclusion.
Taxable income may be in a form other than cash. One example of this is bartering, which is an exchange of property or services. The fair market value of goods and services exchanged is fully taxable and must be included as income on Form 1040 of both parties.
Learn more in Publication 525 -Taxable and Nontaxable Income
Do I Need to File A Tax Return If I Have Tax-Free Income?
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