Understanding Non-Taxable Income: What You Need to Know

Over a single year, you may receive income from a variety of sources. You have to pay taxes on most of the income. However, you can receive certain types of income without having to pay taxes. These sources of income represent your nontaxable income.

Benefits

As of this date of publication, if you file taxes as an individual and your annual income amounts to less than $25,000, then you do not pay income tax on your Social Security income. For joint tax filers, you pay no tax on Social Security if your combined income does not exceed $32,000.

Regardless of your income, you do not pay tax on Supplemental Security Income. Life insurance proceeds are typically nontaxable as are proceeds from compensation payments tied to sickness or injury. You do not pay tax on child support or on veterans benefits, worker's compensation or welfare payments. Disaster relief payments and compensation payments for black lung disease are also nontaxable types of income.

Mortgages

If your lender agrees to a loan modification agreement or a short sale, your lender agrees to erase part of your mortgage debt. The Internal Revenue Service views that debt forgiveness as a type of taxable income. However, the IRS passed a provision in 2007 that allows mortgage debt forgiveness as nontaxable income up to and including 2012.

Municipal Bonds

When you buy a municipal bond, you lend money to a state or local government. That government entity must make regular interest payments to you. Most income payments on municipal bonds are classified as nontaxable income at the federal level. If you buy bonds from government entities in your own state, then you do not have to pay state income tax on those interest payments, which means municipal bonds are often exempt form all types of income tax.

Other Income

If you receive a grant for college expenses, the money that covers your tuition is usually nontaxable income. However, you have to pay taxes on money you use to cover living expenses even if the taxable and nontaxable income are from one source or one grant. You just deduct the amount you used for nontaxable expenses from your taxable income.

If you do not begin making withdrawals from a Roth Individual Retirement Arrangement until you have had the account for at least five years and are 59 1/2 or older, then you receive the money as nontaxable income. Income payments from annuities and other retirement accounts are usually partly taxable and partly nontaxable, because you pay no taxes on your after-tax premiums but do pay tax on earnings.