What are the types of nontaxable income?

Gifts and inheritances

As a recipient, any gifts you receive without providing anything of equal value in return (assets or cash gifts) aren’t considered taxable; any tax burden falls on the giver. The giver also doesn’t pay any taxes unless that person exceeds the lifetime gift tax exemption of $13.61 million in 2024.

This means if Person A gives Person B $60,000 as a gift in 2024, person A will have exceeded the gift limit per person, which is $18,000. The extra $42,000 ($60,000 minus $18,000) counts against their lifetime exclusion.

There is also no federal tax on anything you inherit as a successor. However, if the inheritance generates income (such as a dividend stock earning a profit), you need to report the income to the IRS.

“Inherited money is not considered taxable to the individual at the time of inheritance but the estate of the deceased may have taxes to pay depending on the size of the estate and the state in which they died,’’ Stephen Kates, certified financial planner and principal financial analyst at Annuity.org, told us via an online platform.

“While the Federal estate tax exemption is $13.61M per individual ($27.22M for a married couple) in 2024, many states have much lower exemptions. Pre-tax assets, such as an inherited traditional IRA, will be taxable to the beneficiary only when withdrawn since they have not had taxes paid on them,” Kates explained.

Child support and foster care

Child support isn’t subject to tax for the recipient (and is not deductible by the payer). Also, the subsidy foster parents receive from the government or any other eligible entity is considered support for the child. These funds are, therefore, not included in income for federal tax purposes.

“Neither child support nor foster care income will be included in the recipient's taxable income because it is considered to be a benefit for the child. However, if you receive payments to maintain open space in your home for emergency foster care, these payments must be included in your taxable income,” Kates said.

Life insurance payouts

Life insurance payouts (known as the death benefit) from the death of an insured person are generally not taxable. However, there are a few exceptions, such as when the beneficiary receives the policy in installments instead of a lump sum. In this case, any interest that the money accrues is taxable. In addition, if the policyholder cancels the policy, any cash value the policy has accrued is taxable.

Proceeds above $50,000 from employee-paid group insurance are also taxed. If the beneficiary is an estate, it can be subject to taxes on any value exceeding $13.61 million.

Employer benefits

There are various ways your employer can offer nontaxable financial assistance. For example, if you’re injured at work, you’re eligible for workers' compensation, and it’s tax-free. The compensation can take the form of a wage replacement, medical treatment fee, vocational rehabilitation payments, etc.

Also, if an employer pays the cost of an accident or pays a health insurance plan for their employees, the payments are not wages and are not subject to federal income tax.

Other tax-free employer benefits are educational assistance and adoption assistance. For the latter, taxpayers were allowed to receive up to $15,950 per child tax-free in 2023. They could also exclude up to $5,250 from their taxable income for educational assistance.

Certain scholarships and fellowship grants

Generally, scholarships that pay for qualified educational costs in an institution that maintains a regular faculty and an enrolled body of students are nontaxable. This is the same case with grants you receive to pay for specific schooling costs.

There are a few exemptions, such as when you use scholarship funds to pay for utilities, room and board, travel or other nonqualified expenses. In this case, you’ll need to report these funds as income. Similarly, if part of the funds you receive for the scholarship have the condition that you offer services such as teaching, that amount is considered taxable income.

Welfare benefits

Welfare benefits are provided by government programs to groups or individuals who cannot support themselves. Eligible individuals receive biweekly or monthly payments. The goal of welfare is to promote a standard of living or the pursuit of education and work.

The welfare benefits are nontaxable because they are meant to offer help without introducing new financial burdens to beneficiaries.

Roth IRA distributions

Roth 401(k)s, Roth 403(b) and Roth IRAs are tax-advantaged accounts that allow you to save after-tax dollars. While this means the contributions aren’t tax-deductible, it also means you withdraw the savings tax-free as long as you meet the conditions.

If you’re under age 59 1/2 and your account is under five years old, withdrawing your earnings will require you to pay penalties and taxes.

Municipal bonds interest

Municipal bonds, or munis, are bonds issued by the government to fund community projects. To make them attractive, the interest earned is exempt from federal income taxes. If you purchase a bond from your home state, the interest from munis can also be exempt from state income taxes. It’s a great tax relief option for high-income individuals.

Bottom line

It can feel like the IRS is out to get all your hard-earned money. While tax evasion is illegal, other legal ways exist to cut down your tax bill. One way is taking advantage of tax-free advantaged accounts such as Roth IRA accounts. Being aware of nontaxable income also allows you to file your returns diligently.

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