Exempt IncomeIncome that is not subject to taxation

Generally, any income you receive is subject to tax.

The profit that your business makes?

That’s taxable.

The salary or wage that you receive from your employer?

That’s also taxable.

Even the fringe benefits that your employer provides or the royalties you receive from particular sources might be taxable.

Basically, anything that results in you gaining something may just be subject to tax.

However, the IRS does allow certain types of income to be exempt from taxation.

For example, if you’re single, the first $12,950 (as of 2022) of your gross income is exempt from federal taxation.

This is because this is the amount that the IRS provides as the standard deduction.

And the best part about it? You only need to claim it on your return.

No need to provide or attach any supporting documents on your tax return.

There are also other types of income exempt from taxation… now isn’t that a mouthful?

Let’s refer to these types of income as “exempt income” from now on shall we?

Now while exempt income is not subject to tax, you still have to include and report it on your tax return.

This is why in this article, we will explore what exempt income is. So that we’ll know which income we’ll tag as “exempt income” in our tax returns.

We will be defining what exempt income is.

We will also be exploring the different types of income that the IRS considers to be exempt income.

By the end of this article, we should be able to identify if an income is taxable or not.

Also, have you ever wondered why you still need to report your exempt income on your tax return even if it’s not subject to tax?

Well, read on to find out why.

What is Exempt Income?

Exempt income refers to particular types of income that are exempt from taxation either at the state or federal level or both.

The IRS has an extensive list of taxable and non-taxable income which you can find here.

Did you take a look at the list? It’s okay if you didn’t.

We’ll try to discuss some of them in this article.

There are a lot of income and benefits that may just be exempt income after all.

An example would be the gifts that an individual receives.

In 2022, the first $16,000 of gifts (be it on cash or other assets) is exempt from taxation.

This exemption is on a per-person basis.

Other examples of exempt income include the following:

• (Effective 2018) Alimony payments that are provided for in a divorce or separation agreement entered into in 2019 or later
• Child support payments
• Donations and gifts that charitable institutions receive
• Inheritance and bequests
• Cash rebates on items that you purchase from a vendor (e.g. retailer, manufacturer, or dealer)
• Welfare payments
• Money that is reimbursed from qualifying adoptions
• Most several health-related benefits. This includes employer-sponsored supplemental disability insurance, private insurance plans, employer-sponsored health insurance plans, etc.
• In general, life insurance proceeds you receive as a beneficiary due to the death of the policyholder or insured person. However, any interest that you receive due to the life insurance proceeds is taxable. This is one of the exempt incomes that you don’t have to report in your tax returns
• Money you receive through a scholarship, fellowship grant, or other grants. It should be noted it only becomes exempt income if you meet specific conditions. First, you must be pursuing a degree. Next, the money should be used to pay for tuition and “qualified education expenses” (e.g. books, supplies, etc.)

Deductions and Adjustments to Income

Aside from the types of exempt income listed above, we also so have tax deductions and adjustments to income that further reduce our tax liability.

For deductions, we have the option of itemizing them (which will require supporting documents) or going with the standard deduction.

Adjustments to income include all of your spending on the following:

• Retirement plan contributions
• Deferred compensation plans. Note that this only defers the tax liability. You will still have to pay taxes when you receive the proceeds of the plan. Qualified deferred plans have a yearly limit of $20,500 (in 2022)
• A portion of your self-employment tax provided that you are self-employed
• Student loan interest
• Tuition fees (those not included in a scholarship grant)
• Health savings account (HSA) contributions

Itemized deductions include your spending on the following:

• Medical and dental expenses not covered by your insurance
• Gifts and donations to charitable institutions
• State and local taxes (this includes property taxes)
• Home mortgage interest and points
• Losses due to a federally declared disaster
• Moving expenses

The deductions and adjustments to income listed above have their own set of rules and limitations.

In addition, states may have their own laws for exempt income.

For example, some states may exempt unemployment income, worker’s compensation, Social Security benefits, etc. from taxation.

Reporting Exempt Income

While exempt income is not subject to tax, you still have to report it on your tax return (in general).

The IRS would want to know about all the income that you’re receiving. And by all, that includes exempt income.

The IRS would also want to know about the income that you’re “exempting”.

Essentially, the IRS has to “approve” the items that you claim as exempt income before they do become exempt income.

This will usually involve filing one or more forms in addition to your usual Form 1040 tax return.

Some of the additional forms include Form 8839 (for exempt adoption assistance), Form 2411 (to exclude dependent care benefits), Form 8962 (for medical and dental expenses), etc. To report adjustments to income, you will have to file Schedule 1. To report itemized deductions, you will have to file Schedule A.

Failing to report exempt income, especially those with their own set of rules and limitations, may result in penalties.

Also, failing to report deductions and adjustments to income will result in you paying more taxes than you would have if you reported them.

If the discrepancy in information is significant enough, it may even constitute tax fraud.

So just to be safe, report all of the income that you’re receiving be it taxable or not.

Another tip, don’t just assume that an income is an exempt income.

It’s best to consult a qualified tax professional.

Or you could refer to the many publications that the IRS releases regarding exempt income, adjustments to income, and deductions.