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
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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 1,000nowworth5,000, 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 10,000,valuedat50,000 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: 1,000monthlypaymentwith800 principal and 200interest,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: 10,000scholarshipcovering8,000 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