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What is an Exempt Income?

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  • Written By: Patrick Roland
  • Edited By: Kathryn Hulick
  • Last Modified Date: 27 September 2016
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Exempt income is any money earned that does not need to have taxes taken out. The reasons for this vary between different forms of income, but the exemption is intended to help tax payers by providing added money for daily needs. Money earned from either a job or stocks is considered taxable income. However, things like retirement funds, municipal bonds, gifts, and government-provided income are all free from having taxes taken out.

One of the most common forms of exempt income comes from governmental payments. An exemption from paying taxes is possible on welfare money, workers compensation, and veteran's benefits. Most likely, these are not taxed because they are already coming from the same government that is collecting taxes and also because this money is intended to help those in need of added financial support. Removing a portion through taxes would be counterproductive.

Another government-related form of exempt income is a municipal bond payment. A civil project undertaken by a government, like a bridge building or highway construction project, often requests that citizens purchase municipal bonds to help cover the expenses. These bonds function like a coupon, because after a designated amount of time, the purchaser can return the bond and receive the initial investment money back and usually also interest. The money earned by turning in a bond is not taxed.

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Gifts are another form of earnings that are considered exempt income. Money given, for example in a birthday card, is not taxed by the government. In the United States, though, gifts exceeding $10,000 US Dollars are subject to taxation. Also, in most cases, inheritance money also does not have taxes removed when a sum of money is designated to a beneficiary in a will.

Retirement monies are also not taxed in most cases. Government sponsored retirement plans, like the United States' Social Security, are considered exempt income. Also, many privatized retirement plans avoid being taxed, like a Roth IRA. Some pre-tax retirement benefits are, however, subject to taxation, so it is always best to check with a tax advisor.

Finally, one of the most commonly overlooked forms of exempt income comes in the form of school help. Some scholarships and fellowships do not have taxes removed in many cases. A basic rule is if, in the United States for example, the scholarship requires the recipient to fill out tax forms, like a W-2, then it is not considered exempt income.

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