4.3 Exclusions from gross income
5 min read•july 30, 2024
Exclusions from are key exceptions to taxable income. They include municipal bond interest, certain , , and some government benefits. Understanding these exclusions is crucial for accurately calculating taxable income.
, , , and are also typically excluded from gross income. Many employee benefits, like and certain , are excluded too. These exclusions can significantly impact a taxpayer's overall tax liability.
Income Exclusions
Types of Excluded Income
Top images from around the web for Types of Excluded Income
Reading: Tools of Monetary Policy | Macroeconomics [Deprecated] View original
Is this image relevant?
Federal Income Tax - Free of Charge Creative Commons Financial 3 image View original
Is this image relevant?
Reading: Tools of Monetary Policy | Macroeconomics [Deprecated] View original
Is this image relevant?
Federal Income Tax - Free of Charge Creative Commons Financial 3 image View original
Is this image relevant?
1 of 2
Top images from around the web for Types of Excluded Income
Reading: Tools of Monetary Policy | Macroeconomics [Deprecated] View original
Is this image relevant?
Federal Income Tax - Free of Charge Creative Commons Financial 3 image View original
Is this image relevant?
Reading: Tools of Monetary Policy | Macroeconomics [Deprecated] View original
Is this image relevant?
Federal Income Tax - Free of Charge Creative Commons Financial 3 image View original
Is this image relevant?
1 of 2
- Exclusions from gross income represent specific types of income not subject to federal income tax as defined by the Internal Revenue Code (IRC)
- Interest earned on state and local government bonds () generally excluded from federal gross income
- Compensation for injuries or sickness typically excluded
- Includes workers' compensation benefits and compensatory damages
- Child support payments received not considered taxable income for the recipient
- Certain welfare benefits and government assistance programs excluded
- benefits
- allows U.S. citizens working abroad to exclude a portion of foreign earnings
- Subject to specific requirements and limitations
- Maximum exclusion amount adjusted annually for inflation ($112,000 for 2022)
Common Exclusions Overview
- Gifts and inheritances generally excluded under
- Life insurance proceeds paid due to death of insured typically excluded under
- Qualified scholarships and fellowship grants for qualified education expenses excluded under
- Specific employee benefits excluded
- Employer-provided health insurance premiums
- contributions made by employers
- Certain educational assistance programs
Gifts and Inheritances: Tax Treatment
Gift Tax Considerations
- Gifts generally excluded from recipient's gross income under IRC Section 102
- Donor may be subject to gift tax if value exceeds annual exclusion amount
- Annual exclusion amount adjusted periodically for inflation ($16,000 for 2022)
- Gift tax responsibility falls on donor, not recipient
- Reported on IRS Form 709 (United States Gift and Generation-Skipping Transfer Tax Return)
- Basis of property received as gift typically donor's adjusted basis
- Example: If donor gives stock purchased for 5,000, recipient's basis remains $1,000
- Gifts of income-producing property may result in future taxable income for recipient
- Example: Gift of rental property generates taxable rental income for recipient
Inheritance Tax Considerations
- Inheritances not subject to income tax for recipient
- Estate tax may apply to decedent's estate if value exceeds federal estate tax exemption amount
- Exemption amount for 2022 $12.06 million per individual
- Inherited property receives step-up in basis to fair market value at date of death
- Example: Inherited stock purchased by decedent for 50,000 at death, recipient's basis becomes $50,000
- Income generated from inherited assets after date of transfer generally taxable to recipient
- Example: Interest earned on inherited savings account taxable to beneficiary
Life Insurance Proceeds: Exclusions
Death Benefit Exclusions
- Life insurance proceeds paid due to death of insured generally excluded from beneficiary's gross income under IRC Section 101(a)
- Exclusion applies to both lump-sum payments and installment payments of death benefits
- paid to terminally or chronically ill individuals also excluded
- Subject to certain conditions (e.g., life expectancy of 24 months or less for terminal illness)
- Transfer-for-value rule can result in partial taxation of proceeds if policy transferred for valuable consideration prior to insured's death
- Example: If policy sold to unrelated party, portion of proceeds may be taxable to new owner
Taxation of Related Benefits
- Interest portion of installment payments typically taxable as ordinary income
- Example: 800 principal and 200 taxable
- Employer-provided group term life insurance coverage up to $50,000 generally to employee
- Coverage exceeding $50,000 results in to employee
- Cash value accumulation within permanent life insurance policy tax-deferred
- Policy loans generally not taxable as long as policy remains in force
- Becomes taxable if policy lapses or is surrendered with outstanding loan balance
Scholarships and Fellowships: Tax Treatment
Qualified Education Expenses
- Qualified scholarships and fellowship grants for qualified education expenses excluded under IRC Section 117
- Qualified education expenses include:
- Tuition and fees required for enrollment or attendance
- Books, supplies, and equipment required for courses
- Example: 8,000 tuition and $2,000 required textbooks fully excluded
- Exclusion applies only to degree candidates at eligible educational institutions
- Eligible institutions defined by IRC (generally accredited colleges, universities, and vocational schools)
- Tax-free treatment limited to amount of qualified education expenses incurred during tax year
- Example: 12,000 qualified expenses, $3,000 potentially taxable
Taxable Portions and Limitations
- Amounts received for room and board, travel, or other personal expenses generally taxable
- Example: $5,000 scholarship designated for housing not excludable
- Scholarship or fellowship amounts representing payment for services generally taxable
- Includes teaching, research, or other services required for all candidates for a particular degree
- and other need-based education grants typically treated as qualified scholarships
- Example: $6,495 maximum Pell Grant for 2021-2022 academic year potentially fully excludable if used for qualified expenses
Employee Benefits: Excludability
Health-Related Benefits
- Employer-provided health insurance premiums generally excluded from employee's gross income under IRC Section 106
- Exclusion extends to employee's spouse and dependents
- Health Savings Account (HSA) contributions made by employer excluded from employee's gross income
- Subject to annual contribution limits (7,300 for family coverage in 2022)
- Long-term care insurance premiums paid by employer generally excludable
Education and Retirement Benefits
- Employer-provided educational assistance up to $5,250 per year excludable under IRC Section 127
- Applies regardless of whether education is job-related
- Example: 5,250 excluded and $750 taxable
- Employer contributions to generally excluded from employee's current gross income
- Includes 401(k) plans, 403(b) plans, and SIMPLE IRAs
- Example: $5,000 employer match to 401(k) not included in current year's taxable income
Additional Fringe Benefits
- Certain fringe benefits excludable under specific IRC provisions
- De minimis fringe benefits (e.g., occasional meals, holiday gifts)
- Qualified employee discounts
- Transportation fringe benefits may be excluded up to specified monthly limits
- Qualified parking ($280 per month for 2022)
- Transit passes ($280 per month for 2022)
- Working condition fringe benefits excludable
- Example: Use of company car for business purposes
Key Terms to Review (27)
Accelerated Death Benefits: Accelerated death benefits are payments made to policyholders of a life insurance policy who are diagnosed with a terminal illness or certain chronic conditions, allowing them to access a portion of their death benefit while still alive. This financial assistance can help cover medical expenses or living costs, easing the burden on families during difficult times. The amount received is deducted from the total death benefit payable upon the insured's death, meaning beneficiaries will receive a reduced amount.
Adjusted Gross Income: Adjusted Gross Income (AGI) is the total income of an individual, calculated by taking gross income and subtracting specific deductions, also known as adjustments. AGI serves as a critical figure in determining tax liability and eligibility for various tax credits and deductions, influencing many aspects of tax calculation, including the choice between the standard deduction and itemized deductions.
Child Support: Child support refers to the financial payments made by a non-custodial parent to the custodial parent for the expenses related to raising their child. These payments are intended to cover a variety of costs, including food, housing, education, and healthcare, ensuring that the child's needs are met after a separation or divorce. In terms of gross income, child support payments are typically not considered taxable income for the recipient and are not tax-deductible for the payer.
Compensation for injuries: Compensation for injuries refers to payments received as a result of physical injuries, sickness, or emotional distress caused by accidents or wrongdoings. These payments can come from insurance claims, legal settlements, or judgments and are generally not taxable under federal income tax law, making them exclusions from gross income. This classification is important as it ensures that individuals who suffer injuries are not further burdened by taxes on the compensation intended to make them whole.
Educational Assistance: Educational assistance refers to financial support provided to individuals for educational purposes, such as tuition, fees, and related expenses. This assistance can take various forms, including grants, scholarships, and employer-provided educational benefits, which are often excluded from gross income for tax purposes, thus reducing the overall tax burden on the recipient.
Employee Business Expenses: Employee business expenses are costs that employees incur while performing their job duties, which can include travel, meals, lodging, and other necessary expenses. These expenses may be reimbursed by the employer or deducted from the employee's taxable income. Understanding how these expenses fit into the overall framework of exclusions from gross income is crucial for determining what amounts can be excluded when calculating taxable income.
Employer-provided health insurance: Employer-provided health insurance is a type of health coverage offered to employees by their employers, which can significantly contribute to an employee's overall compensation package. This coverage often includes various medical benefits such as hospital visits, preventive care, and prescription drugs, and is typically provided at a lower cost than individual plans. Notably, the value of these benefits is excluded from an employee's gross income, making it a key aspect of tax considerations.
Excludable Income: Excludable income refers to specific types of income that the Internal Revenue Code allows taxpayers to exclude from their gross income, meaning they do not have to report it for tax purposes. This concept is crucial as it helps taxpayers understand which sources of income are not subject to taxation, thus potentially lowering their overall tax liability. By recognizing excludable income, individuals can effectively plan their finances and tax strategies.
Foreign Earned Income Exclusion: The foreign earned income exclusion allows U.S. taxpayers who live and work abroad to exclude a certain amount of their foreign-earned income from their taxable income. This exclusion is designed to prevent double taxation, enabling individuals to keep more of their income earned in foreign countries without being taxed by the U.S. on the same earnings. This provision encourages American citizens to work overseas and helps them adjust to financial realities of living outside the U.S.
Gifts: Gifts are transfers of property or money from one individual to another without expecting anything in return. In the context of taxation, gifts are significant because they generally do not count as gross income for the recipient, allowing individuals to receive financial support without incurring tax liabilities on those amounts.
Gross income: Gross income refers to all income received by an individual or entity before any deductions or taxes are applied. It serves as the starting point in determining taxable income and is a crucial component of the tax formula, impacting basic calculations for determining overall tax liability.
Health Savings Account (HSA): A Health Savings Account (HSA) is a tax-advantaged savings account designed for individuals with high-deductible health plans, allowing them to save money specifically for medical expenses. Contributions to an HSA are made pre-tax, reducing taxable income, and funds can be used tax-free for qualifying medical costs. HSAs are unique because they offer triple tax benefits: contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free.
Imputed Income: Imputed income refers to the economic benefit that a taxpayer receives from non-cash sources, which is not directly paid out in cash but still increases their overall financial position. This concept connects to the idea that some benefits, like employer-provided services or perks, can be viewed as income even if they don’t result in actual cash payments. Recognizing imputed income is essential for understanding how various exclusions from gross income apply and how they can impact a taxpayer’s overall taxable income.
Inheritances: Inheritances refer to assets passed down from a deceased individual to their heirs or beneficiaries, typically through a will or state laws. These assets can include cash, real estate, stocks, and personal property. Understanding how inheritances are treated for tax purposes is essential because they can affect the overall gross income of the recipient and may have specific exclusions.
IRC Section 101(a): IRC Section 101(a) provides the framework for excluding certain types of income from gross income, specifically focusing on amounts received under life insurance contracts. This section helps clarify that death benefits paid to beneficiaries are generally not subject to federal income tax, promoting financial relief during a difficult time. It is a key provision that ensures the beneficiaries do not face tax burdens on these funds meant for their financial support after the insured individual's death.
IRC Section 102: IRC Section 102 provides the framework for the exclusion of certain gifts and inheritances from gross income for federal income tax purposes. This section essentially states that gifts and inheritances are not considered taxable income, allowing individuals to receive assets without the burden of income tax on the value received. This exclusion plays a vital role in ensuring that wealth transfers do not create an additional tax liability for the recipient.
IRC Section 117: IRC Section 117 pertains to the federal tax treatment of scholarships and fellowship grants, specifically stating that amounts received as scholarships or fellowship grants are excluded from gross income under certain conditions. This provision ensures that students can receive financial support for their education without facing tax implications, provided the funds are used for qualified expenses such as tuition and fees.
Life Insurance Proceeds: Life insurance proceeds are the benefits paid out to a designated beneficiary upon the death of the insured individual. These proceeds are typically excluded from gross income for tax purposes, meaning they are not subject to federal income tax. This exclusion is important as it ensures that beneficiaries receive the full benefit of the insurance without being burdened by tax liabilities.
Moving Expenses: Moving expenses refer to the costs associated with relocating an individual or family from one residence to another. These expenses may include transportation of belongings, travel costs, and certain expenses related to the new home, and they can be significant during a job-related move. Understanding how moving expenses are treated under tax law is crucial, especially regarding whether they can be excluded from gross income.
Municipal Bonds: Municipal bonds are debt securities issued by state or local governments to finance public projects, such as building schools, highways, or hospitals. They are attractive to investors because the interest earned on these bonds is often exempt from federal income tax and sometimes state and local taxes, making them a valuable tool for both funding public initiatives and providing tax benefits to investors.
Pell Grants: Pell Grants are federal financial aid awards provided to low-income undergraduate students to help cover the cost of higher education. These grants do not need to be repaid, making them a vital resource for students seeking to reduce their financial burden while pursuing a college degree. Understanding Pell Grants is essential for navigating the landscape of educational funding and the potential exclusions they offer from gross income.
Qualified Retirement Plans: Qualified retirement plans are tax-advantaged savings plans that meet specific requirements set by the Internal Revenue Service (IRS) and allow participants to save for retirement while deferring income tax on their contributions and earnings. These plans must adhere to certain guidelines, such as contribution limits and non-discrimination rules, which ensure fair access and benefits for all eligible employees, making them a popular choice for both employers and employees when planning for financial security in retirement.
Qualified Scholarships: Qualified scholarships are financial awards provided to students to help cover the costs of their education, which can be excluded from gross income for tax purposes. These scholarships must be used for qualified educational expenses, such as tuition and fees, and cannot be in exchange for services or obligations. Understanding the specifics of qualified scholarships is crucial for determining their tax implications and ensuring compliance with federal income tax regulations.
Supplemental Nutrition Assistance Program (SNAP): The Supplemental Nutrition Assistance Program (SNAP) is a federal assistance program that provides food-purchasing support for low- and no-income individuals and families. It is designed to help alleviate hunger and improve nutrition among eligible participants by offering them benefits that can be used to buy food at authorized retailers. Understanding how SNAP interacts with gross income is essential, as benefits from this program are generally excluded from taxable income, which can impact the overall financial picture of recipients.
Tax-exempt organizations: Tax-exempt organizations are entities that are exempt from federal income tax under specific provisions of the Internal Revenue Code. These organizations typically serve charitable, educational, religious, or other public purposes and are allowed to receive tax-deductible contributions from donors, enhancing their ability to fund their activities and missions.
Tax-free: Tax-free refers to income or benefits that are not subject to taxation under the Internal Revenue Code. This means that individuals or entities do not have to include this income in their gross income when calculating their tax liability. Understanding what qualifies as tax-free is crucial for individuals looking to minimize their taxable income and maximize financial benefits.
Temporary Assistance for Needy Families (TANF): Temporary Assistance for Needy Families (TANF) is a federal assistance program that provides financial aid and support services to low-income families with children. It aims to promote self-sufficiency by offering temporary cash benefits, job training, and other services designed to help families achieve economic independence. TANF is crucial in the context of income tax, as the benefits received are typically excluded from gross income, thus impacting tax liability for recipients.