What is Tax-Exempt Income?

In the United States, most money that is received by a person is subject to federal and state income tax. There are, however, some types of income that a person is allowed to receive without having to share any portion of it with the government. This is known as tax-exempt income.

At the end of a tax year, most of the money earned by individuals or business entities typically should be calculated and disclosed on the relevant tax forms. Based on a series of subsequent calculations, the amount of tax that is owned is calculated. This is known as income tax.

Some income is exempt from federal taxes without exception. Examples of these include welfare benefits, federal tax returns, and veteran benefits. The federal government does not under any circumstances attempt to claim ownership to any part of these funds.

A person usually should be careful when deciding whether certain other items are tax-exempt income or not. There are some categories where this determination is dependent upon the circumstances. These categories include scholarships, inheritances, and interest income. Individuals and business entities are responsible for being aware of the rules regulating these categories.

It also is important to note that some tax-exempt income must still be reported. This is the case, for example, with interest income. There is a space on the appropriate tax form for disclosing tax-exempt interest income.

Everyone does not pay the same tax rates. The amount of income that is received helps to determine into which tax bracket individuals and business entities fall. If a person is in one tax bracket, tax-exempt income, even when disclosed, should not push her into another tax bracket.

The tax-exempt categories set forth by states can be different than those set forth by the federal government. Some states do not charge personal income taxes. Other states exempt items that the federal government does not, such as pensions. In some instances, income that is exempt from federal tax obligation is not exempt from state tax obligation. An example is the money received from a federal income tax return.

Tax-exempt income is an issue that can carry consequences if it is not properly handled. When a person believes that she has income that is tax-exempt, it is wise to get advice from tax preparation professionals or to completely pass the responsibility of calculating income tax to them. This especially is true when a person believes that she has several categories of tax-exempt income.