Even though there’s more income that’s taxable than not, there’s still nontaxable income you aren’t required to report to help reduce your tax liability. To determine what is nontaxable income, the government provides specific guidelines, so you aren’t clueless when it’s time to prepare your tax return.
This post provides general guidelines on what is nontaxable income and what isn’t. At the end of the tax year, you should have a clearer understanding of the type of income to include on your tax return.
What Is Nontaxable Income?
Here’s how the IRS defines the difference between taxable and nontaxable income. “All income is taxable unless the law specifically excludes it.” It’s essential to consult with a tax professional when you aren’t sure whether to report specific income sources.
You can also review IRS Publication 525, which provides a detailed explanation of taxable and nontaxable income by category.
Examples of Nontaxable Income
Below is a general list of income the IRS considers nontaxable.
It’s not a complete list based on an entity’s business structure and other factors. For example, partnerships and S Corporations do not generally pay federal tax because gains, losses, and deductions are passed to partners and shareholders. Those individuals do, however, pay self-employment taxes on distributions.
- Welfare benefits
- Cash rebates from a manufacturer
- Life insurance proceeds – the amount over the face amount of the policy is taxable
- Scholarship income – What you spend on tuition and books is nontaxable, but the money received for room and board, travel, and optional equipment is.
- Gifts and inheritances
- Child support payments
- Damage awards for injury or sickness
- Reimbursements for qualified adoption expenses
- Workers’ compensation – a portion of workers’ compensation benefits may be taxable if you also receive Social Security Disability Insurance or Supplemental Security Income. You would need to check with an attorney to make sure.
- Income from Roth IRAs and Roth 401Ks
What’s Considered Taxable Income?
Again, this isn’t an all-inclusive list.
- Self-employment income
- Wages and salaries
- Unemployment compensation – you should receive Form 1099-G, which will show how much compensation you need to report. Just so you know, unemployment compensation doesn’t count toward qualifying for an earned income tax credit (EITC).
- Severance pay – your past employer, should include severance pay in your W-2 statement that you receive at the end of a calendar year.
- Dividends and interest – interest on government municipal bonds is nontaxable. Dividends are usually taxed when you receive back the investment as a share of profits.
- Rental income
- Non-cash income from property – When two people barter for goods and services, they must include the fair market value of what they receive as income on their tax returns.
- Fringe benefits – examples include company-paid memberships, company-paid tuition fees that exceed a certain amount, or specific portions of employer-paid dependent care.
- Gambling winnings – you should receive a copy of W-2G. Even if you don’t receive the form, you should report any winnings that exceed losses as income.
- Miscellaneous income – Example: income from offshore accounts, income reported on IRS Form 1099-MISC, royalties, prizes, and awards.
Other FAQs Regarding What is Nontaxable Income
Here are a few answers to common questions about nontaxable income.
1. What are the tax rules when you give or receive cash?
The annual exclusion for gifts in 2019 is $15,000. The exclusion limit applies to each donee.
For instance, if you’re a single parent, you can give $15,000 to each of your children for a total of $60,000 or $120,000 when you and your spouse jointly give each child $30,000. The person/people who receive the gifts do not report the money as income as long as the gift doesn’t exceed $15,000/$30,000 per donee.
2. Are disability payments taxable or nontaxable?
It depends on who pays the premiums. If your employer pays the premiums, the total amount is taxable. If you pay the premiums, the amount is nontaxable. There’s one caveat. Disability payments related to government services are usually nontaxable.
3. If you sell your home, how much is taxable?
The IRS is interested in the capital gains you realized when selling your home. The first $250,000 of profit is excluded from taxation, which increases to $500,000 when filing a tax return jointly. You must have lived in the home for the two of the last five years and have taken the exclusion within two years between home sales.
4. When is prepaid income considered taxable?
Income that’s advanced as compensation for future services is generally reported in the year it’s received. However, you can defer the income to a different accounting period when you earn it or complete the service.
An example would be receiving advance rent from a tenant at the end of one year who will occupy the rental space the following year. You can carry the rent received as a liability and then transfer the amount to rental income when the tenant takes occupancy.
5. Is jury duty always taxable?
Jury pay is considered a miscellaneous income. Depending on the court, you may receive a 1099-G or 1099-MISC statement. You can turn over your jury pay to your employer in exchange for continuing to earn wages. Then, report the income and adjust your gross income to avoid paying tax.
We’ve Got Your Back
By having a better idea of what is nontaxable income and taxable income, you won’t feel like you’re in the dark come tax time. You can move forward confidently without wondering which income you need to include.
By completing an accurate tax return you increase your chances of being approved for a business loan? Information on your tax return helps lenders decide whether to provide funding for your business needs.
At Camino Financial, we fulfill our motto, “No Business Left Behind,” every time we make available to readers information like the one you just read. We provide free tools and resources to help you grow your business.