You might think that nontaxable income is money that you can plausibly leave off your tax return. However, that’s not the case. Nontaxable income won’t be taxed even if you include it on your tax return. On the flip side, leaving income off your tax return won’t shield you from taxes. It just means you’ll be liable for those taxes, plus late fees and penalties, when the IRS figures it out — and they usually do. For questions about your specific income tax liabilities, consult an accountant or tax advisor.
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Nontaxable Income Examples
The IRS provides a chart on nontaxable income limits — or how much you need to earn before you’re required to file an income tax return. For example, a single person age 65 or over can earn up to $14,250 without needing to file a federal tax return. A head of household under age 65, meanwhile, can earn up to $18,800 without needing to file.
There are many other types of income besides what appears on a W2 or 1099. Here are examples of income that’s nontaxable, even if you might think otherwise.
- Inheritances and bequests. Money and other assets you inherit are typically exempt from federal income tax. That’s because any taxes are levied before the estate is settled, and the threshold for estate taxes is high: $12.92 million in 2023.
- Cash gifts. In 2023, gifts up to $17,000 are excluded from taxes. Above that, the gift giver typically pays the tax.
- Rebates. This refers to cash you receive back from a retailer, manufacturer, or dealer.
- Life insurance payouts. If cashed in after someone dies.
- Scholarships. If used to pay school tuition and fees. However, when the funds are used to pay for room and board or personal expenses, they may be taxable.
- Alimony for divorces finalized after 2018, and child support payments.
- Welfare payments
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How Taxable Income Works
All taxable forms of income must be listed on your IRS return and will count toward whatever tax bracket you’re in.
Taxable income can include funds that aren’t yet in your bank account, such as when a check arrives but you don’t cash it during the tax year. The IRS offers examples of this to provide clarity. For instance, if your mail carrier tries to deliver a check to you on the final day of the tax year but you “are not at home to receive it,” that counts as income for the current year. If the check was mailed but couldn’t reach you during the tax year, that money goes toward next year.
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Types of Taxable Income
Taxable income comes in three forms: money, property, and services. Money includes wages, salaries, self-employment income, and commissions; royalties, strike pay; rental income; and alimony if the divorce was finalized before 2019. Stock market gains are another example of taxable income.
Fringe benefits are typically taxable. This category could include a company vehicle, holiday gifts from your employer in cash or gift certificate form, an off-site gym membership, or childcare services.
It’s important to keep track of all your financial transactions for tax time. It can help to use a spending app that provides high visibility of your finances in one place.
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Nontaxable vs Taxable Income
Putting money away for retirement often involves depositing funds into a tax-sheltered account to benefit from the IRA or 401(k) tax deduction. With these accounts, there’s a tax impact when you make your contributions or withdraw your money but not at other times. These retirement accounts come with annual contribution limits, though, so you may decide to invest in taxable accounts when those limits are reached.
When opening a taxable brokerage account, the goal is tax-efficient investing instead of the tax-deferred investing that happens with an IRA or 401(k). This can include investing into long-term stocks or municipal and treasury bonds.
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Examples of Income That Is Both Taxable and Nontaxable
If your employer pays for your tuition, it can be nontaxable. But if it goes over a certain amount, it can become taxable. The same is true with employer-paid group life insurance. You may also want to take a close look at the category of “unearned income.”
Unearned income is passively earned income that you make without working. This can include retirement distributions, Social Security benefits, interest from bank accounts, stock dividends, and so forth. It also includes debt cancellation or forgiveness, which can be taxable or nontaxable, depending whether it was canceled or forgiven for less than the amount due.
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How to Reduce Your Tax Liability
Reducing taxable income makes good sense. Some strategies to consider include:
- Choosing the right filing status
- Maxing out your retirement contributions
- Deducting qualified health care expenses
- Opening a 529 savings plan if your children may attend private school or college
Another strategy is to reduce or avoid capital gains tax. You can do that a few ways:
- Donating appreciated shares of stock. This applies when you have held the stock for more than a year.
- Selling stocks at a loss to offset capital gains, which can reduce your taxable income.
- Investing in property via a Qualified Opportunity Fund. You can temporarily defer paying taxes on your gains.
Each of these strategies can be complex, and professional help is recommended.
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The Takeaway
The IRS divides income into taxable and nontaxable categories. With the second, the income may or may not need to be listed on your federal tax return, even though taxes aren’t owed. Some common forms of nontaxable income include inheritances, cash gifts of $17K or less, scholarships that cover school tuition and fees, alimony, child support, and welfare payments. Taxable income can be “earned” on the job, as with wages, salaries, and commissions. Unearned income is the term for passive revenue, such as stock gains in taxable accounts, interest on savings, and benefits you receive from your employer.
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