Exempt Income: Definition, Examples, and Tax Rules (2024)

What Is Exempt Income?

Exempt income refers to certain types of income not subject to income tax. Some types of income are exempt from federal or state income tax or both. The IRS determines which types of income are exempt from federal income tax and the circ*mstances for each exemption. States have their own rules that define what counts as exempt income.

Key Takeaways

Exempt income is not subject to taxation.
Some income may be exempt at the state level but taxed at the federal level.
Income from some types of investments, like municipal bonds, qualifies as exempt income.
Distributions from Roth 401(k)s and Roth IRAs are tax-exempt.
Income from benefits, such as employer-sponsored supplemental disability insurance and most benefits from employer-sponsored health insurance plans, are exempt from taxes.

Understanding Exempt Income

Some income and benefitsarenontaxableunder certain circ*mstances. Several health-related benefits are tax-exempt, including benefits from employer-sponsored supplemental disability insurance purchasedwith after-tax dollars, private insurance plans funded with after-tax dollars, most benefits from employer-sponsored health insurance plans,and worker's compensation.

Gifts that exceed a certain value can trigger a gift tax on the person providing the gift. However, any giftworth less than $17,000 in 2023 and $18,000 in 2024 is exempt from income tax. Regardless of value, gifts, including medical expenses paid for someone else and charitable donations, are income tax exempt. Charitable contributions are also tax-deductible.

The Tax Cuts and Jobs Act (TCJA) in 2017 eliminated personal exemptions from tax years 2018 to 2026 but roughly doubledthe standarddeduction. For tax years 2023 and 2024, the standard deductions are:

2023 and 2024 Standard Deductions
	2023 Tax Year	2024 Tax Year
Single Taxpayers and Married Couples Filing Separately	$13,850	$14,600
Married Couples Filing Jointly	$27,700	$29,200
Heads of Household	$20,800	$21,900

When you file your taxes, you can choose between taking thestandard deductionoritemizingyour deductions. Examples of itemized deductions include medical expenses, mortgage interest, and charitable donations.

Examples of Exempt Income

Distributions from health savings accounts (HSAs)are only exempt from income tax if they are used for qualified medical expenses. Qualified distributions from Roth 401(k) plans and Roth IRAs funded with after-tax dollars are tax-exempt.

Other investments may also be protected from income tax. For example, interest earned from municipal bonds is exempt from federal and state income tax if you reside in the state where the bond was issued. Capital losses from sold investments can also reduce your taxable income by up to $3,000 annually.

If someone dies and you are the beneficiary ofa life insurance benefit, that is also nontaxable income but may be subject toestate tax. The estate tax, or death tax, applies to a portion of an estate after it exceeds a certain threshold, $12.92 million in 2023 and $13.61 million in 2024.

Thealternative minimum tax (AMT) exemptions are in effect until 2025.The 2023 exemption amount was $81,300 with a phase-out of $578,150 for individuals and $126,500 for married couples filing jointly with a phase-out of $1,156,300. For tax year 2024, the exemption is $85,700 for single filers and begins to phase out at $609,350. For married couples in 2024, it's $133,300 for married couples filing jointly, with phase-out at $1,218,700.

What Types of Income Are Tax Exempt?

Income from municipal bonds and distributions from Roth 401(k)s and Roth IRAs are tax-exempt.Income from employer-sponsored benefits—including supplemental disability insurance and most benefits from employer-sponsored health insurance plans—are exempt.

Is Unemployment Income Taxed?

Unemployment benefits are treated asordinary incomeby the federal government, but not all states tax unemployment income. Unemployment compensation is taxed based on the program paying the benefits.

How Much Is the Gift Tax?

In 2023, giftsworth less than $17,000 are not subject to income tax. This value increases to $18,000 in 2024.

The Bottom Line

Almost all forms of income are taxable including wages, salaries, tips, and other types of income from an employer or as a freelancer. But certain forms of income aren't taxable. Exempt income includes things like distributions from some retirement accounts, gifts under a certain amount, certain benefits, and private insurance plans.

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