The amount you must pay in taxes depends largely on the amount of your income. It can be reduced by how many personal itemized deductions you can claim or by your business’ expense deductions. But another way to reduce your taxes is if you determine that any of the income you have received qualifies as nontaxable income.
When you receive money for goods or services you provide, it is considered income. Income is defined as an accession to wealth; it is an increase in your property. Examples of taxable income are wages, salaries, commissions, dividends and interest, self-employment income and unemployment compensation.
Congress has determined that some items are taxable income even though at first you might not think they would be taxable. An example is cancellation of debt income which you receive if your debt has been forgiven. Another example is unemployment compensation, which generally is taxable.
Nontaxable income, in contrast, is income that is not subject to federal income tax. This type of income has been exempted by tax laws. Examples of nontaxable income include gifts, inheritances, life insurance proceeds, cash rebates, alimony payments (if the divorce was finalized after 2018), child support payments, welfare payments, and federal tax refunds.
Life Insurance – if you receive funds from a life insurance policy upon someone’s death, these funds are not taxable. But if you cash in a life insurance policy at least a portion of the funds you receive will be taxable.
Inheritance – inheritances are not taxable, but any interest or other income earned after someone’s death is taxable to their estate.
Fringe benefits – you may receive benefits such as a company vehicle for personal use, tuition, or dependent care assistance from your company, or even an off-site gym membership paid by your company. These fringe benefits are paid to you for services you render to your company and are taxable even if someone else, such as your child or spouse receives the benefits. Even gifts and gift cards from your employer are considered taxable income because they are considered as paid to you for the services you render to your company.
Scholarships – a scholarship is considered to be nontaxable income if the person is enrolled full-time and the funds are used to pay for qualified expenses, such as tuition. But if the funds are used to pay for living expenses such as room and board the IRS will consider the scholarship funds to be taxable.
Cryptocurrency – digital currencies are treated as property by the Internal Revenue Service. If you mine cryptocurrency, the value of the cryptocurrency at the time it is mined is considered taxable self-employment income. It is also considered income if you receive crypto for goods or services. If you use cryptocurrency to purchase goods or services, it is considered a sale of the cryptocurrency for its value at the time you used it as payment. When you sell cryptocurrency, you must pay taxes on any gain (the difference between the price you paid for it and its value when you sold it.)
Pensions – Payments from a pension or annuity payments are usually considered taxable income unless the payment is from a Roth IRA.
Sale of Primary Residence – if you have lived in your home as your principal residence for at least two of the five years before you sell it, you can qualify to exclude up to $250,000 of the gain from the sale. If you are married and file a joint return, you can exclude up to $500,000 of the gain from the sale. We have seen situations where the IRS asserts that tax is owed on the sale of a home that had been used as the client’s principal residence. In these situations, we have successfully been able to show the IRS that our client qualified for the principal residence exclusion and the IRS has abated the tax.
Some other types of income that are nontaxable are Energy Conservation Subsidies, Foster Care Payments, Political Contributions, and Municipal Bond Income.
For additional information on what qualifies as taxable and nontaxable income see IRS Publication 525.
If you have questions about whether or not you need to report certain types of income on your tax return, or if the IRS has asked you to pay tax on income that you think is nontaxable, feel free to contact us. You can call our office or schedule a phone call here. We are here to help.
Robert V. Boeshaar Attorney at Law, LL.M.,PLLC
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