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What is Tax Exempt Income

Tax exempt income is income that is not taxable. Since the Internal Revenue Service (IRS) views all income as taxable, it can become difficult to find tax-free income. Whether you are working for a paycheck or collect Social Security benefits, there are income sources that are tax-free. Continue reading to discover ways you can legally reduce the income on your tax return.

Finding tax-free income

There are many forms of tax-free income available for taxpayers. Ask a tax Expert to see what you can claim as tax-free.

Insurance provided by employer

The IRS does not consider accidental or health plan coverage provided by your employer to be taxable income. Also, contributions to a health savings account made by an employer or employee are not taxable.

Income earned in nine states

States can make their own laws. While most income is taxable on a federal level, some states do not levy a state tax on income. States who do not choose to charge a tax are

  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

With this ruling, states encourage people to move there.

Corporate income earned in six states

States also encourage corporations to move to their state by not taxing corporate income. These states do not charge corporate taxes:

  • Nevada
  • Ohio
  • South Dakota
  • Texas
  • Washington
  • Wyoming

Relocating corporations to these states can help their overall economy.

Municipal bond interest

Investing in municipal bonds will give you a tax-free income. When you earn money from bonds, it is considered tax-free income if you live in the same state they were issued. The tax exemption applies to both individual municipal bonds and if you purchase them through a municipal bond fund. You may end up ahead by investing in municipal bonds in your after-tax return even though municipal bonds offer a lower rate of return than others. Municipal bonds are recommended for high-income individuals or married couples who fall in the 28 - 39.6% federal income tax brackets.

Benefits for veterans

Tax-free income includes benefits paid under any law, regulation or through the Department of Veteran Affairs (VA). Benefits include, but are not limited to

  • Education, training, and subsistence allowance
  • Disability compensation and pension payments for disabilities paid to veterans or their families
  • Grants
  • Insurance
  • Benefits under a dependent care assistance program
  • Death gratuity
  • Payments made under the compensated work therapy program
  • Bonus payment because of service in a combat zone

Capital loss

If you sell investments at a loss, then your taxable income will be reduced by up to $3,000 per year. You can carry your capital losses over each year until the entire loss is offset.

Employer reimbursement

When you are reimbursed for something you have already bought, it is not taxable income. For example, if you have paid for a health or accident plan, do not include any amount of money you receive from sickness or personal injury as income.

Social Security benefits

If Social Security is your only stream of income, it will be tax-free. If, however, you have income in addition to Social Security, some of your benefits will be taxed.

Reducing income

The most effective way to lower your taxes is to reduce your taxable income. Take these steps to lower your taxable income on your next income tax return.

Standard Deductions

You can claim standard deductions from your taxable income if you do not itemize deductions. Standard deductions include the following:

  • Age: If you are 65 years of age or older, you increase your standard deduction up to $1,550 if you file single or head-of-household. If you or your spouse are 65 years of age or older, and you are filing jointly, you can increase the deduction by $1,250. If you and your spouse are 65 years of age or older, you can increase the standard deduction by $2,500.
  • Blindness: If you are legally blind, you can increase the standard deduction up to $1,550 if you file single or head-of-household. If you or your spouse is legally blind, you can increase your deduction by $1,250. If both of you are legally blind, you can increase the standard deduction by $2,500. For the IRS to recognize you as legally blind, you must keep a certified letter from your eye doctor in your tax records.
  • Disaster Loss: Your standard deduction amount can be increased by the net worth of any disaster loss. It must be considered a federally declared disaster.

Contribute to retirement savings plan

Currently, you can contribute up to $18,000 - $24,000 if you are 50 years of age or older without it being considered taxable income. If you have not contributed this much to your savings plan, do so before the tax year is over. If you have a self-employment income, you can contribute up to 20% of that net income to a Simplified Employee Pension. The contribution limit is currently $53,000.


Making charitable contributions before the end of the tax year will reduce your taxable income. Hang on to credit card statements, receipts or other proof of a cash donation. You must get an acknowledgment from the charity if the contribution was over $250.

Appreciated securities, also known as stock, is another type of charitable contribution that will reduce your taxable income. When you donate stock that you have had for more than one year, you can deduct the full value on the date of the gift. Taxes will not have to be paid.

If you have received a gift or an inheritance, it is not included in your gross income. If, however, property received this way becomes income producing in the future, it also becomes a taxable income. Inheritance will not be reported on your income tax return, but will be taxed if it is distributed from an inherited pension or annuity.

Pay property tax bill early

You will be able to deduct your property tax payment from your taxable income if you pay it before the end of the tax year. Ask a tax Expert to see if this is a good idea for you.


If the investments you made in taxable income stocks are not doing well, sell them before the end of the tax year and use the losses to offset capital gain income. If you had more losses than profit, you could deduct up to $3,000 from your taxable income. If the loss is more than that amount, you can carry it over to future years.

Defer income until next year

If you are granted a year-end bonus, ask that it be paid the following year. That way, your taxable income does not increase. If you are self-employed, send bills to clients in late December.

Selling principal residence

Individuals and married couples can exclude up to $250,000 (individual) and $500,000 (couple filing jointly) from their income of capital gains from the sale of their home. To be eligible, they must have owned the home for at least of the last five years and have lived in it for the same length of time.  

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