Taxable And Tax Free Sources Of Income
Most income is taxable. However, you might not have to pay tax on certain types of income. Income can come to you in the form of money, property, or services. Read on to gain insight into sources of taxable and nontaxable income.
The most common types of taxable income are:
- Wages, salaries, and tips — By law, your employer must send you a W-2 that shows how much you were paid in:
- Tips — To learn more, see the Tip Income tax tip.
- Vacation pay
- Sick pay
- Severance pay
- Extra cash from side jobs –Extra money you make for side jobs is taxable and is considered self-employment income. Report this income on Schedule C. If you make more than $400 from your side job, you’ll need to file a Schedule SE and pay Social Security and Medicare taxes on the income.
- Alimony — If you receive alimony as a result of a divorce decree or separation agreement executed prior to 2019, the payments you receive are fully taxable. If you paid alimony during the year, you can deduct it even if you don’t itemize deductions.
- Unemployment benefits — Unemployment compensation benefits are fully taxable.
- Jury duty pay — Jury duty payments are taxable. However, you can deduct any part of the payment you give to your employer in exchange for continuing your salary.
- Pension and annuity payments — Pension and annuity payments are taxed. However, a portion might be tax-free.
- Awards — If you receive an award from your employer for your job performance, it’s usually taxable. The award’s fair market value (FMV) is included in your W-2 income. This can include an all-expenses-paid trip or some other type of goods or services.
- Barter income— The FMV of property or services you receive or provide in exchange for work done is taxable income. Report this income on Schedule C. You can use another form or schedule if you barter property items instead of services.
- If you’re a member of a barter exchange, you should receive a Form 1099-B. This shows the FMV of all property and services you traded during the year.
- Disability payments — If your employer pays the premiums for your disability insurance, disability payments you receive are usually fully taxable. However, if you pay the premiums, the payments you receive are tax-free. Veterans’ disability benefits and workers’ compensation are also tax-free.
- Gambling winnings — Gambling winnings are fully taxable and include:
- Lottery payouts
- Sweepstakes payouts
- Bingo winnings
- Raffle winnings
- Casino winnings
- Prizes — All prizes are taxable. If you win a prize, you must include the FMV of the prize in your income.
Tax Free Income
These are the most common sources of tax free income:
- Auto rebates — A rebate is actually a reduction in price of the auto. It isn’t taxable income. However, a rebate reduces your basis in the auto.
- Alimony — For divorce or separation decrees executed after 2018, alimony is not taxable to the recipient and is no longer deductible for the payer.
- Carpool receipts — If you drive a carpool to and from work, you don’t need to report payments you receive from passengers. These payments are considered reimbursement for your expenses, not income.
- Child support payments —Child support payments are tax-free to the recipient, and the payor can’t deduct the payments.
- Casualty insurance proceeds — If you’re reimbursed for a loss, like a car accident or house fire, you usually don’t have to report the income on your return. However, you should include the payment when you figure any gain or loss from the casualty or theft. Some of these payments might be taxable.
- Combat pay — You qualify for tax-free income treatment for each month you were present in a combat zone and you’re one of these members of the military:
- Enlisted member
- Warrant officer
- Commissioned warrant officer
If you’re a commissioned officer who served in a combat zone or was hospitalized as a result of your service, the amount you can exclude is limited to the total of:
- Highest rate of enlisted pay
- Imminent-danger pay
- Hostile-fire pay
Commissioned warrant officers can exclude all military pay for each month present in a combat zone.
- Damages — Some types of damages received from a legal settlement may qualify as tax-free income sources. This includes compensation you received for:
- Damages for a personal physical injury or sickness
- Emotional distress suffered as a result of the personal physical injury or sickness.However, if you receive compensation a payment for these types of damages, the income is taxable:
- Lost wages or profits
- Punitive damages
- Dividends on a life insurance policy — Premiums are usually paid with after-tax dollars. So, dividends you receive are considered to be an overpayment of your premium. These are usually tax-free. If the dividends you receive are more than the premiums you paid, the excess amount is taxable.
- Coverdell education savings accounts (ESAs) — Withdrawals from these accounts are tax-free if:
- You use the money to pay for qualified education expenses (Ex: tuition, books, and fees).
- The money is for the designated beneficiary enrolled at an eligible educational institution.
- Gifts — Gifts are not taxed for income purposes. If federal gift tax is owed on the gift, the giver owes the tax. So, you don’t usually need to report the receipt of gifts or pay gift or income tax.
- Health and accident insurance plans and benefits — Generally, the value of employer-provided health plan coverage isn’t included in income and is tax-free. If you’re reimbursed for medical expenses you paid out of pocket, the money you receive isn’t taxable. You also don’t have to pay tax on compensation received for the:
- Permanent loss of the use of part of the body
- Permanent disfigurement
- Health savings accounts (HSA) — Contributions by you or your employer to an HSA are tax-free income if they’re used to pay qualifying medical expenses. Nonqualified use of an HSA can result in taxable income.
- Inheritances — Any money or property you inherit is tax-free unless the item is considered to be income in respect of a decedent (IRD). Items like retirement accounts are usually considered to be IRD. If you inherit a traditional IRA or company retirement benefits, you may have to include part of the inherited amount in your income.
For inheritances, your basis is usually the property’s FMV on the day the person who gave it to you died. You need to know the basis of the property so you can figure the amount of capital gain or loss you’ll have when you dispose of the property.
- Life insurance — Life insurance proceeds you’re paid as beneficiary of an insured person aren’t taxable. However, if you receive the proceeds in installments over a number of years, the interest earned on that account is taxable income. If you buy an annuity with life insurance proceeds, the annuity you receive will be taxed as a pension from a nonqualified plan, not as interest income.
- Municipal bond interest — If you receive interest on bonds issued by state and local governments, the interest is usually tax-free. However, the interest is taxable income if both of these apply:
- You’re subject to the Alternative Minimum Tax (AMT)
- Public safety officer survivor benefits — If you’re a survivor of a public safety officer killed in the line of duty, you may be able to exclude certain survivor benefit income. Public safety officers include:
- Law enforcement officers
- Rescue squad members
- Ambulance crew members
- Profits on the sale of a home — If you sell your main home and lived in that home for at least two of the five years before you sold it, you might be able exclude up to $500,000 of profit from taxable income on a joint return. If you’re single, the exclusion limit is $250,000.
- Roth IRA withdrawals — Withdrawals up to your contribution amounts are always tax-free. Also, after you turn 59 1/2, are disabled, or a beneficiary, or qualify for the “first home” exception all withdrawals you make — including earnings — are tax-free if the account has been open for at least five years.
- Scholarships and fellowship grants — If you use scholarship or grant money for tuition and related expenses, the money is tax-free. This includes these required expenses:
However, if you use any of the money to pay room and board, that portion is taxable income.
- Social Security payments — Depending upon your income and filing status, Social Security benefits may be entirely tax-free or partly taxable. Ex: If your income is more than $25,000 — or $32,000 if married filing jointly — up to 85% of your Social Security benefits may be taxable.
- State and local tax refunds — You might have received a refund of your state or local income tax you claimed as an itemized deduction on your prior-year return. If so, usually a portion of your state or local income tax refund is taxable. However, even if you itemized, part of the refund could be tax-free.
- Veterans’ benefits — Veterans Affairs disability payments are tax-free.
- Workers’ compensation — If you receive workers’ compensation for an injury you suffered on the job, that compensation is tax-free. However, you must receive the payment under a workers’ compensation statute or a similar statute.
Where to Go for More Help With Reporting Tax-Free and Taxable Income
To learn more about reporting taxable and non-taxable income, consult a tax professional. File with a tax pro at a location near you.
Have you found yourself wondering how the IRS classifies Bitcoin? Our tax pros discuss relevant IRS Bitcoin law and notices. Learn more with H&R Block.
There are two different types of IRAs - traditional and ROTH. Use this IRA calculator from Betterment and H&R Block to determine which one is best for you.
What is a capital gain or loss, and how do they affect your taxes? Learn more from the tax experts at H&R Block.
If you’ve contributed too much to your IRA for a given year, you’ll need to contact your bank or investment company to request the withdrawal of the excess IRA contributions. Depending on when you discover the excess, you may be able to remove the excess IRA contributions and avoid penalty taxes.