Over 100 years in the past, the United States adopted the income tax to pay for federal government services. While the value of each service is debatable, the tax code is designed to fund them while encouraging some behaviors and discouraging others.
Tax-free income, in particular, is so designated to spur charitable giving, environmentally-sound practices, and scientific innovation, for example. A reputable Chicago CPA firm can assist taxpayers with discerning between taxable and non-taxable income. Federal income tax filing is less stressful with experts to help.
Sources of Taxable Income in 2023
The government's share of your 2022 household or business revenue depends largely on how much money came in and what the taxpayer's filing status was during the year. Out of the gross income, the following are subject to taxable income:
- Typical employee compensation in the form of wages, salaries, tips, and sales commissions;
- Bonuses and fringe benefits linked to work performance;
- Revenue from businesses and investments;
- Income from partnerships and other enterprises held with others;
- Royalties for writing or other published original content;
- Money made from crypto-currencies;
- The estimated value of goods received through sale and trading.
In other words, when you receive funds in exchange for the value you provide through labor, investment, or bartering, those count as taxable income per the Internal Revenue code.
What Is Untaxable Income?
What are we talking about when we speak of non-taxable income? In essence, this is compensation that is not classified as taxable income. Non-taxable income, therefore, refers to financial gains that are shielded from income tax.
What, Then, Is Considered Non-Taxable Income
1. Accelerated Death Benefits
Accelerated death benefits are life insurance proceeds that are disbursed in advance of the policyholder's demise. Most insurers make this tax-free provision available. These monies are not included as gross income.
2. Child Support
In the case of divorce or if the marriage never took place between parents, child support payments are income to be sure. However, the custodial parent who is the primary guardian receives child support payments and need not include them as taxable income. On the other hand, the absent parent making the payments is required by the Internal Revenue Service (IRS) to maintain those monies in the taxable category.
3. Disaster Relief Assistance
Another form of tax-free income is money released for recovery from disasters of natural or human origins. These grants are left intact by the Internal Revenue Service.
4. Employer Assistance
Also tax-free, are employer-paid monies that serve as financial aid in adopting a child or paying tuition.
5. Employer-Provided Accident and Health Plans
Here, too, employer-provided insurance premiums for coverage are likewise subtracted from the tax liability.
6. Employer-Provided Group Term Life Insurance
For premium amounts of $2,000 or less, term life insurance premiums for which the employer pays are counted as non-taxable income.
7. Energy Conservation Subsidies
To stimulate the use of renewable energy and sustainable practices, the government offers direct or indirect subsidies as well as creating incentives whereby users need not pay taxes on funds spent on alternative fuels.
8. Foster Care Payments
Yet another area of tax-free revenue concerns remuneration to those serving as foster parents. The expectation is that the funds, like child support payments, apply directly to the care and raising of children.
9. Financial Gifts
Gifts, i.e., the conveyance of financial value from one party to another, are generally tax-free because it is assumed that givers already pay taxes on the asset. However, if the gift is of high value yet not a financial instrument, the recipient might owe tax based on the estimated resale proceeds.
10. Benefits for the Ill or Injured
Disability benefits for those unable to work due to sickness or medical trauma are often not considered taxable income. Still, there are exceptions with disability benefits, e.g., if the receiver is also claiming the earned income credit on the tax return, or if the receiver is getting retirement benefits.
11. Inherited Wealth
Assets passed down to successors by wills or other means are usually viewed as immune from the income tax. Once received, though, these funds may yield interest or appreciation which is, in fact, taxable income.
12. Municipal Bond Income
Municipal bonds represent debt obligations from states and cities that are incurred in the interest of creating or improving infrastructure. These municipal bonds are seen as safe investments that return dependable if limited rewards in the form of municipal bond interest. Generally, they are exempt from taxation if they are issued in the taxpayer's home state.
13. Death Benefits from Life Insurance
Life insurance awards a death benefit to the beneficiaries of the deceased. The life insurance death benefit is non-taxable income in and of itself.
14. Income from Sale of Primary Residence
In most cases, the conveyance of a primary residence, like all real estate, is a capital gain per the IRS, therefore taxable income. Even so, some sellers with limited incomes will be taxed at a rate of zero percent.
15. Roth IRA Distributions
Unlike traditional individual retirement accounts (IRAs) where the distributions are taxable at the back end, Roth IRA contributions are taxed upfront. Distributions, therefore, represent non-taxable income.
16. Scholarships, Grants, and Financial Aid
Monies paid on behalf of a student to cover tuition and associated expenses may serve as tax-free income. A caveat to this fact is that the amount given must not exceed the expenses approved by the IRS. Room and board, for instance, is not an approved expense.
Taxable vs. Nontaxable Income: Gray Area Revenues
Money from Legal Settlements
The IRS looks at the legal foundation of the settlement and the facts of the case before determining taxable and non-taxable income.
The default Internal Revenue Service stance on Social Security payments is that they are non-taxable income sources. Still, with a high enough level of non-Social Security revenue, then the Social Security benefit can be considered taxable income, at least in part.
Home Sale Proceeds
As noted earlier, selling a house opens the sales amount received to capital gains taxation. If income drops below a predetermined threshold, at any rate, the tax rate will be zero.
How to Reduce Tax Liability
Per the above, professional assistance is a resource well worth utilizing. You can take a few steps too. If the near future is the issue, switching from a Roth to a traditional IRA will assure your retirement plan contributions are shielded from taxation.
So, make them as high as possible so you can protect more hard-earned money from federal or state taxes. Timing the sale of stocks, bonds, and other assets can also reduce the burden. These and other moves will help lower the taxable income side of the equation.
In any event, a certified public accountant can provide more detailed information with regard to lowering your tax liability.
Contact a Tax Professional to be on the Safe Side
With rules as complex - some say convoluted - as those governing taxation in the U.S.s, even seemingly easy decisions come with a shadow of a doubt. Employing a certified public accountant Lewis.cpa well-grounded in the tax code provides not only peace of mind, but also confidence that your return is a reliable representation of your financial realities. Contact us today to discuss how we can partner with you to submit a return that answers every question.