Income Exclusion Rule: What it is, How it Works (2024)

What Is the Income Exclusion Rule?

The income exclusion rule sets aside certain types of income as non-taxable.

There are many types of income that qualify under this rule, such as life insurance death benefit proceeds, child support, welfare, and municipal bond income. Income that is excluded is not reported anywhere on Form 1040.

Key Takeaways

Income excluded from the IRS's calculation of your income tax includes life insurance death benefit proceeds, child support, welfare, and municipal bond income.
The exclusion rule is generally, if your "income" cannot be used as or to acquire food or shelter, it's not taxable.
Municipal bond income is only excludable up to a point.

Understanding the Income Exclusion Rule

Generally, there is no limit to the amount of this type of income that can be received. One exception is municipal bond interest, which may be counted back as an alternative minimum tax preference item.

Income Exclusion Rules and Social Security

For Social Security purposes, not everything an individual receives is consideredincome. For the most part,if anitem received cannot be used as, or to obtain, food or shelter, it will not be considered as income.

For example, if someone pays an individual's medical or automobile repair bills, or offers free medical care, or if the individual receives money from a social services agency that is a repayment of an amount he/she previously spent, that value is not considered income to the individual.

In addition, some itemsconsidered to be income are excluded when determining the amount of an individual's benefit.A detailed list of social securityincome exclusions can be found in sectionV.B of the SSI Annual Report.

Principal EarnedIncome Exclusions

The first $65 per month plus one-half of the remainder
Impairment-related work expenses of the disabled and work expenses of the blind
Income set aside or being used to pursue a plan for achieving self-support by a disabled or blind individual
The first $30 of infrequent or irregularly received income in a quarter

Principal UnearnedIncome Exclusions

The first $20 per month
Income set aside or being used to pursue a plan for achieving self-support by a disabled or blind individual
State or locally funded assistance based on need
Rent subsidies under HUD programs and the value of food stamps
The first $60 of infrequent or irregularly received income in a quarter

Income Exclusions for Employer-Paid Health Insurance

One of the biggest tax exclusionsin the U.S. is the exclusion that allows workers who get job-based (or "employer-paid") health insurance coverage not to pay taxes on the value of those policies andemployers to deduct the cost as a business expense.

The exclusion is projected to cost the Treasury at least $303 billion in 2021, according to Congress’ Joint Committee on Taxation and the Congressional Budget Office.

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Now, let's delve into the concepts mentioned in the article on the Income Exclusion Rule:

Income Exclusion Rule:

The Income Exclusion Rule refers to a set of regulations that designate certain types of income as non-taxable. The key idea is that income falling under this rule is not considered in the calculation of income tax. Some key points related to this rule include:

Types of Excluded Income:
- Life Insurance Death Benefit Proceeds: Monies received from a life insurance policy due to the death of the insured.
- Child Support: Payments made to support a child after a divorce or separation.
- Welfare: Financial aid provided by the government to those in need.
- Municipal Bond Income: Interest earned from municipal bonds.
Exclusion Criteria:
- Generally, if the income cannot be used for food or shelter, it is not taxable.
Limits on Municipal Bond Income:
- Municipal bond income exclusion has a limit, especially concerning alternative minimum tax preference items.

Income Exclusion Rules and Social Security:

Definition of Income for Social Security:
- Not everything received is considered income; it must be usable for food or shelter.
Exclusions for Social Security Determination:
- Items like payments for medical or automobile bills, free medical care, or repayments from social services may not be considered income.
Social Security Income Exclusions:
- Detailed exclusions are outlined in section V.B of the SSI Annual Report.

Principal Earned and Unearned Income Exclusions:

Earned Income Exclusions:

The first $65 per month plus one-half of the remainder.
Impairment-related work expenses of the disabled and work expenses of the blind.
Income set aside for pursuing a plan for achieving self-support by a disabled or blind individual.
The first $30 of infrequent or irregularly received income in a quarter.

Unearned Income Exclusions:

The first $20 per month.
Income set aside for pursuing a plan for achieving self-support by a disabled or blind individual.
State or locally funded assistance based on need.
Rent subsidies under HUD programs and the value of food stamps.
The first $60 of infrequent or irregularly received income in a quarter.

Income Exclusions for Employer-Paid Health Insurance:

One of the significant tax exclusions is for workers with job-based health insurance coverage.
The exclusion allows workers not to pay taxes on the value of employer-paid health insurance, and employers can deduct the cost as a business expense.
The projected cost of this exclusion was at least $303 billion in 2021, according to Congress’ Joint Committee on Taxation and the Congressional Budget Office.

These concepts collectively illustrate the complexity and diversity of income exclusion rules in various contexts, providing individuals and businesses with valuable insights into how different types of income may be treated for tax purposes.