Forget deductions and tax credits. In the best of all possible worlds, you receive tax-free income. This is income on which you don’t have to pay any federal income tax. Some types of income are tax free to everyone; some apply only if your overall income is below set levels or are subject to other limits. Here is a rundown of 25 different types of tax-free income.
Tax Free for Everyone
Some types of income are tax free regardless of your other income.
- 529 plan distributions for qualified higher education costs.
- Accelerated death benefits paid from a life insurance policy to a terminally ill individual.
- Accident and health benefits.
- Black lung benefits.
- Child support payments.
- Coverdell education savings account distributions for qualified education costs.
- Credit card cash backs.
- Crime victim payments from state funds for this purpose.
- Damages for personal physical injury.
- Dealer or manufacturer rebates.
- Debt discharged during insolvency or bankruptcy.
- Debt forgiveness on a principal residence for debt up to $2 million.
- Disability payments under a policy for which you paid the premiums.
- Disaster relief grants.
- Discounts on purchases you make.
- Employee fringe benefits, such as employee discounts, working condition fringe benefits, and de minimis fringe benefits.
- Federal income tax refunds.
- Food benefits under the Nutrition Program for the Elderly.
- Foster care payments.
- Frequent flyer miles.
- Gain on the sale of qualified small business stock held more than 5 years.
- Gifts. The recipient isn’t taxed, regardless of the amount of the gift; the donor may owe federal gift taxes.
- Grants for homes designed for wheelchair living of disabled veterans.
- Grants for motor vehicles for certain disabled veterans.
- Historic preservation grants under the National Historic Preservation Act.
- Interest on insurance dividends left on deposit with the Veterans Administration.
- Life insurance proceeds received on the death of the insured.
- Loan proceeds. Borrowed funds are never taxable.
- Meals and lodging on employee premises that meet certain requirements.
- Military allowances.
- Ministers’ housing allowance.
- Mortgage assistance payments under the National Housing Act.
- Moving expenses paid or reimbursed by an employer.
- Municipal bond interest. Interest may also be free of state-level taxes.
- Peace Corps payments for housing, food, utilities, and clothing.
- Rent of a residence up to 14 days in the year.
- Retirement planning advice paid by an employer.
- Roth IRA distributions, provided they are made after 5 years and on account of age 591/2 or for certain other reasons.
- Scholarships and fellowships for tuition and fees.
- Student loan debt cancellation by a qualified lender for working in certain professions.
- Supplemental Security Income (SSI).
- Veterans benefits.
- Welfare benefits.
- Workers’ compensation benefits.
Income-Dependent Tax-Free Income
Some types of tax-free income are treated as such only if your income does not exceed set levels. Different definitions of income apply for different types of tax-free income. Some are based on adjusted gross income or modified adjusted gross income, while others depend on taxable income. There are also unique definitions of income, such as “provisional income.”
- Social Security benefits. They are tax free only for those with “provisional income” up to $25,000 if single, or $32,000 if married filing jointly. Married persons who file separate returns can never have tax-free Social Security benefits.
- Qualified dividends. They are tax free to taxpayers in the 10% or 15% tax bracket. For 2011, this means individuals with taxable income up to $69,000 for joint filers and $34,500 for single taxpayers.
- Capital gains. Long-term capital gains are tax free to taxpayers in the 10% or 15% tax bracket. For 2011, this means individuals with taxable income up to $69,000 for joint filers and $34,500 for single taxpayers.
- COBRA subsidy. The federal government pays 65% of premiums up to 15 months for workers involuntarily terminated between September 1, 2008, and May 31, 2010.
- Savings bond interest used to pay for higher education. This tax-free income depends on modified adjusted gross income, which is adjusted annually for inflation.
Limited Tax-Free Income
Some types of income are tax free up to a certain amount.
- Adoption assistance from an employer. In 2011, the limit is $13,360; modified adjusted gross income limits apply.
- Dependent care assistance up to $5,000 annually.
- Educational assistance from an employer education plan up to $5,250 annually.
- Foreign earned income. In 2011, the limit is $92,900.
- Free employee parking. In 2011, the limit is $230 per month.
- Gain on the sale of a principal residence. The limit is $250,000 for singles and $500,000 for joint filers.
- Group term life insurance paid by employers for coverage up to $50,000.
- IRA distributions transferred to charity by those age 701/2 and older up to $100,000 annually.
- Monthly transit passes. In 2011, the limit is $230 per month.
- Prizes to employees (usually up to $1,600).