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18 Tax-Free Sources of Income

Not all income is treated equal. Ordinary income is treated the worst by the tax code. Long-term capital gains are granted preferential tax treatment. And some income is excluded from income entirely.

When planning for retirement or any financial goal, taxes play a vital role in how quickly the goal is reached. The more tax-free income you acquire the better.

The tax code in the U.S. taxes all income unless specifically excluded by the code. Many sources of tax-free income is limited in scope, applying to very unique and special situations.

The list below contains 18 sources of federal tax-free income. States usually follow federal, but may have more or fewer items of tax-free income. Every reader should find several types of non-taxable income available to them from the list.

What is not on the list is phantom tax-free income. Loans are a prime example. Loans are not income! They are a liability. Cash-value life insurance is another tool sometimes touted as providing tax-free benefits when the touted tax-free benefits are a half truth (usually a form of borrowing your own money).

You can also save and/or print out a shortened version of the list by clicking the image below. Keep this handy guide close so you don’t miss any of the juicy opportunities for tax-free income.

18 tax-free sources of income. Click on the image to open in a separate page for easy download and printing. Note: This placard only provides the highlights. It is important you review the source material in the blog post for the details on the non-taxable source of income.

Credit Card Rewards

Credit card cash back and bonus awards are tax free. So are the airline miles. The IRS considers them a rebate, treating the bonus as a reduction in the price paid for the products and services purchased with the credit card.

If you enjoy playing the credit card game you might even get more cash back than you spent using the credit card. And it is still non-taxable.

WARNING: While credit card rewards are tax-free and not included in income or reported on your tax return, bank product bonuses are considered interest income. You will get a 1099-INT from the bank if you received a sign-up bonus for a savings or checking account.

Life Insurance Proceeds

If you are the beneficiary of a life insurance policy, the income is not reported on your tax return or subject to income tax. The proceeds must be from the death of the insured (§101). Interest paid on the proceeds after the insured’s death is taxable.

Life insurance might be included in the insured’s estate.

Accelerated death benefits are excluded from income if the ensured is terminally ill, where death is expected within 24 months. A physician’s certification is required.

Accelerated death benefits for the terminally ill, used for long-term care services, are also excluded from income. Per diem benefits over $400 per day in 2021 are included in income.

Insurance Claims

This one is tricky. What appears to be tax-free income might really be an adjustment to the basis of the property.

What is clearly tax-free income from an insurance claim? Damages paid to you due to physical injury or sickness, including emotional distress related to the injury (§104(a)).

Medical reimbursements not previously deducted are excluded from income.

Insurance claims paid in excess of basis of the property damaged is included in income. A totaled auto is usually excluded from income unless the value of the vehicle increased since you purchased it and the claim exceeded basis. Vehicles used in business have a reduced basis; some of the insurance claim for property damage might be included in income.

Property damages to your home (fire, burglary) paid by insurance are excluded from income unless the payment exceeds basis or is used to replace the damaged, destroyed or stolen items.

Note that insurance proceeds from lawsuits, like punitive damages, are included in income.

Health Savings Account

The HSA might be the best thing going in the tax code.

If you have an HSA qualified health insurance plan you can make a deductible contribute to an HSA savings account. The contribution limit for 2021 is $3,600 for self-only coverage and $7,200 for family coverage. All gains are tax-free if used for qualified medical expenses. (Generally, if the medical expense can be claimed on Schedule A the expense is qualified for payment from your HSA.)

The HSA savings account can not be used to pay medical insurance premiums. But can be used to pay Medicare premiums when you reach age 65.

Roth IRA and Roth 401(k) Gains

Roth retirement plans are funded with after-tax income, but grow tax-free.

Note: Contributions to your 401(k) can either be traditional or Roth. However, the employer’s match is always a traditional contribution.

Long-Term Capital Gains, Part 1

There is currently a high cap for long-term capital gains (LTCG) taxed at 0% ($80,800 for joint returns; $40,400 for single and married filing separately returns; $54,100 for head of household returns for 2021).

This means if your only income is from LTCGs in 2021, those LTCGs can be $105,900 ($25,100 standard deduction + $80,800) before you begin paying tax.

When other income is involved the amount of LTCGs in the 0% tax bracket is reduced. A back-of-the-envelope way to think of this is to add all your income, putting the LTCGs at the top. Any amount under the threshold is taxed at 0%. Some readers would be wise to tax-gain harvest if they have an unused amount of 0% tax bracket for LTCGs.

Long-Term Capital Gains, Part 2

If you want to get serious about avoiding taxes on your long-term capital gains, consider moving to Puerto Rico.

Long-term capital gains earned while a bona fide resident of Puerto Rico are exempt from federal income taxes. (Puerto Rico taxes may apply.)

A bona fide resident of Puerto Rico can still work remotely and keep their investments and real estate in the U.S. as long as you don’t keep a tax home outside Puerto Rico. The catch is that you must be a bona fide resident of Puerto Rico. If you are interested in this tax strategy I recommend reading the link in this paragraph.

Foreign Income Exclusion

Up to $108,700 (for 2021) of foreign income can be excluded from income. You must be physically present in the foreign country or countries for at least 330 full days of 12 consecutive months.

Opportunity funds can still save your serious tax dollars by breaking the income into more than one year, converting short-term into long-term capital gains and, until the end of 2021, a 10% reduction in the capital gain.

Opportunity Funds

This tax strategy made a splash when the Tax Cuts and Jobs Act of 2017 first became law and is not heard of much anymore. That is too bad because there are still two serious tax plays to reduce taxes using opportunity funds (OF).

OFs are a way of deferring capital gains. No like-kind exchange is required. Simply invest the gains, or a portion thereof, into an OF within 180 days of realizing the gain and exclude that portion of the gain from your taxes. There is no income limit or limit on how much capital gains can be deferred.

A portion could become tax-free in five years with a bit more in seven years. The seven year window is closed and the five year window closes at the end of 2021, unless Congress acts to extend the deadline (not expected).

Also, OFs can turn a short-term capital gain windfall into a long-term gain. If the gains are invested in an OF within the 180 day window, the gain is deferred. If held in the OF for at least a year and a day you now have a long-term capital gain, along with the lower tax rate for such gains.

The second tax strategy is a timing issue. You are not required to invest all your gains into the OF. Therefore, you can have some of the gain taxed in the current year and the remainder in a future year of your choice up to December 31, 2026. At the end of 2026 the gains are added back into income regardless if you take your money out of the OF.

You can read more about OFs here.

Employer Benefits

Smart employers compensate their employees with a litany of tax-free fringe benefits. The employee gets tax-free income while the employer gets a full deduction. Here are just a few of the possibilities:

  • Retirement plan matching or profit sharing
  • Health insurance
  • Noncash gifts such as a holiday ham
  • Up to $50,000 of group term-life insurance
  • HSA and MSA contributions
  • Adoption assistance
  • Qualified transportation
  • Retirement planning services
  • Qualified dependent care benefits
  • Employee discounts of goods and services normally offered to clients
  • Education assistance

There is one more monster tax-free fringe benefit employers can offer for a limited time. The CARES Act expanded, and the Consolidated Appropriations Act extended, the education assistance benefit to include student loans through 2025. Up to $5,250 of student loans payments are excluded from the employee’s income while the employer enjoys the deduction. Note: Educational assistance is capped at $5,250 for all educational assistance, including student loan repayments.

Workers’ Compensation Benefits

If you are injured at work, the workers’ compensation paid for lost wages, medical expenses and settlement are excluded from income. This includes workers’ compensation paid to survivors. (§104(a))

Survivors of public safety officers killed in the line of duty receiving a government plan annuity exclude that income. (§101(h))

Sick pay and on-the-job injury for railroad workers is excluded from income. (§105(i))

No-fault car insurance benefits for loss of earnings or earning capacity are excluded from income.

Foster Care Stipends

Foster care stipends are excluded from income if there is no profit motive. Expenses are not deductible unless expenses exceed the stipend. The excess expenses are a charitable deduction.

Caring for a Disabled Family Member

The Caregivers Act provides resources to pay people caring for a disabled family member. The wages paid in such situations can be excluded from income. The disabled family member must live with you.

This Medicare funded program attempts to keep disabled persons out of nursing home facilities and with their families. You will get a W-2, but no income will be listed, only the total payment in Box 12.

The author has personal experience with this. Frequently you will receive a W-2 claiming the income as reportable. Have the organization paying the wage amend the W-2. Normally future W-2s will accurately show no income to include on your tax return. If the W-2 shows a wage and you can not get it amended, include it in your tax software and mark the W-2 as not included in federal income.

Disability Benefits

Generally, if you pay the premiums with after-tax dollars for a disability policy, the benefits are tax-free. If your employer pays the premiums the benefits are taxable.

Tax-free income in retirement is the best kind. With a modest amount of planning, your tax liability can tax a serious hair cut.

VA Benefits/Military Pension/Social Security

VA payments to veterans and their families are excluded from income in the following situation:

  • Pensions for disability
  • Disability payments
  • Subsistence, grants, education, training, insurance proceeds payments
  • Dividends and death gratuity

Social Security benefits are either fully or partially excluded from income. Regardless of income, 15% of Social Security benefits are excluded from income. You can determine the amount of your taxable Social Security benefits here.

Generally, none of your Social Security benefits are taxable if your combined income is $25,000 and under for singles and heads of household; $32,000 for joint returns.

Up to 50% of benefits are included in income if your combined income is between $25,000 and $34,001 for singles and heads of household; $32,000 and $44,001 for joint returns.

Up to 85% of benefits are taxable if income is above $34,000 for singles and heads of household; $44,000 for joint returns.

Scholarships, Fellowships and Tuition Discounts

§117 states amounts received by a degree candidate used for tuition and fees required for enrollment, books, supplies and required course equipment is not taxable.

Reduced tuition when the student or parent of student in an employee is not reportable income.

Reduced tuition paid to a graduate student performing teaching or research activities is not considered payment for services.

Degree candidates receiving amounts from the National Health Services Corps or Armed Forces scholarship program for tuition, fees, books, supplies, and equipment is not taxable, even if for services.

Municipal Bonds

Municipal bond interest is not taxable on your federal tax return. However, the income can affect the taxability of other income in some instances (Ex. Alternative Minimum Tax)

Municipal bond interest is also excluded for residents of issuing states, with some exceptions.

Capital gains on municipal bonds are taxable.

Gifts and Inheritances

Gifts and inheritances received are not included in income.

However, the giftor might be required to file a gift tax return.

If you inherit a traditional retirement account or non-qualified annuity you will include the income on your tax return when distribution are received.

Doing good can be good for your wallet. Some caregiver and volunteer work is excluded from income.

Volunteer Income

Most income from a volunteer organization is taxable income. There are a few exceptions:

  • Payments from the Peace Corps for living expenses
  • Supportive service payments and expense reimbursements received from the National Senior Services Corps programs or from the Service Corps of Retired Executives (SCORE)

As I researched this blog post I came across additional tax-free income opportunities. The 18 sources of tax-free income listed above were common enough to make the list. Non-taxable income is frequently very specific in nature. That is a blog post for another day.

Be sure to subscribe (link at the top of this post) and comment on which sources of tax-free income you use or ones that I missed.

As always, thank you for visiting.


Sunday 21st of November 2021

Keith - can you direct me to a link on the Caregivers Act you mentioned that has more specifics? My neighbor's husband had a very bad stroke and she provides all of his caregiving. Thanks,

Keith Taxguy, EA

Monday 22nd of November 2021

Ally, it is hard to find information on this. I'll add a link in the post and here. Let me know if you have any questions.


Friday 29th of October 2021

Hi Keith-

Don't forget what comes after foster care stipends, if you go this route with your family: post-adoption subsidies.

Great stuff, as always.

Mo Mohan

Saturday 23rd of October 2021

Keith, need a couple of clarifications: 1) If ordinary income (MFJ) is above $105,900, the 0% rate for LTCG is lost. The LTCG will be taxed at the next tax rate - 15%. Correct? 2) 0%, 50% or 85% of Social Security income is considered ordinary income depending on the level of Combined Income.

Keith Taxguy

Saturday 23rd of October 2021


#1) Yes. If OI exceeds $105,900 the 15% tax bracket kicks in as the 0% bracket has been surpassed.

#2) Social Security included in income is taxed at ordinary rates.