While the general rule is that all income is taxable and anything that increases your wealth is taxable, it’s not always the case. To lower your tax bill, it is important to know what you can claim as non-taxable income.
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Income From Municipal Bonds
Municipal bonds generate interest earnings for investors who can claim the income tax-free in most cases.
Purchasing municipal bonds issued by the state in which you live results in tax-free earnings on interest. Income earned from interest on local government municipal bonds is generally not taxable either.
Municipal bonds are featured in portfolios created by many robo-advisory firms, such as Vanguard Personal Advisory Services.
Qualified Scholarship Funds
Scholarship funds related to tuition are not taxable but applying those funds to other uses, such as rent does incur a tax liability on that portion.
Scholarship funds used to pay for tuition is tax-free but if you dip into those funds to pay for room and board expenses, you are subject to taxes on that portion.
Selling Investments At A Loss
Selling investments at a loss creates non-taxable income that results in a deduction of up to $3,000 from gross annual salary.
When an investment is sold for a loss, it may be treated as non-taxable income with deductions up to $3,000 permitted from gross annual salary.
Selling investments that are below water against investments that are making money is part of a strategy called tax-loss harvesting, which many robo-advisors, such as Wealthfront, employ to create tax-optimized portfolios.
Six states impose inheritance taxes but many beneficiaries may be exempt, such as spouses.
When a spouse receives money or property from a deceased person, federal inheritance tax is generally not payable unless the the asset received is income-producing, such as rental property or dividend-producing stocks – in which case the income earned is taxed.
A state inheritance tax may be payable although only six states (Pennsylvania, Kentucky, Maryland, New Jersey, Nebraska, Iowa) have an inheritance tax and even then beneficiaries may be exempt if they fall into certain categories. For example, most states exempt a spouse from an inheritance tax liability. Children and other dependents may also qualify for an exemption.
Gifts, such as tuition and medical expenses as well as charitable contributions, that children receive from parents are free from tax liability.
Although gifts are generally taxable, exceptions to the rule exist. When children receive gifts, such as tuition and medical expenses, they are free from tax liabilities too. When taxes are payable to the IRS, they are paid by the giver and not the receiver.
Gifts received by employers up to an amount of $25 are non-taxable but taxes are applied on larger amounts.
Money From Life Insurance Policy
Money received from life insurance policy is tax-free when a person is deceased but life insurance policy proceeds received when someone is alive are taxable.
When someone dies, money received from an insurance policy is not taxable. Note that if a life insurance policy is cashed in but someone has not died, the cash received is taxable.
Disability Insurance Premiums
Worker’s compensation or disability insurance premiums are generally not taxed by the IRS unless paid for by an employer.
When accidents occur that result in illness or injury, disability insurance premiums received are non-taxable unless they were paid for by an employer. However, if disability insurance was purchased through a business using after-tax income, it is considered non-taxable.
Medical Care benefits provided by a Health Savings Accounts (HSAs) or Health Reimbursement Arrangements (HRAs) are not taxable. Any benefits received from public welfare funds are also tax free.
Income from employers to support couples and individuals who are adopting a child is not-taxable up to certain threshold levels.
Fringe benefits offered by employers sometimes include adoption assistance. Employer-financed adoption assistance is excluded from some federal withholding taxes provided that assistance is provided through a qualified adoption-assistance program approved by the IRS. Qualified adoption expenses according to the IRS include legal fees (attorneys, court costs) and travel expenses.
Individuals or couples looking to adopt may receive employer assistance of up to $13,460 in 2016 and $13,570 in 2017 per child tax-free.
The IRS states that if your employer pays more than $5,250 in educational benefits for you during the year that you are obligated to pay tax on the amount over that threshold.
The Internal Revenue Service allows the first $5,250 of educational assistance from employers to be counted as non-taxable income. Above that amount, a tax liability ensues.
The way it works generally is that your employer includes in your wages (Form W-2, box 1) the amount you must include in income.