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10 Sources of Tax Free Income

Introduction

Okay, so you want to make some more money, but you don’t want to pay more income taxes. How can you swing that without an expensive accountant to help you? By making income that isn’t taxed.

For example, here is no tax on inheritances of up to $5.49 million, generally life insurance proceeds are not taxable, and disability insurance benefits aren’t taxable, at least if you paid the premiums yourself. Workman’s compensation benefits are also generally tax-free.

Of course you don’t want to wait until somebody dies or you become disabled, right? So we’ll skip those kinds of income. Instead let’s look at ten types of tax-free income that you might be able to arrange right now or in the near future..

Note: I’ve linked to the appropriate sources here so you can verify the relevant tax rules for yourself, but if you’re not sure in a particular case, consult a tax professional.

1. Cash Gifts

Ask mom and dad for financial help. There’s no tax on gifts of any size for the receiver. It’s the person who gives the gift who is taxed, and according to the IRS, gifts of up to $14,000 per year are not taxable even for the giver.

That $14,000 exclusion is per-person, by the way. That means if you can talk mom and dad into each giving you the maximum, neither they nor you will owe any taxes on the $28,000 gift.

Non-cash gifts (which you could turn into cash by selling them) fall under the exclusion too, as long as the market value of the item doesn’t put the total gift amount over $14,000 for the year.

2. Cash From Selling Your Things

Rummage sale proceeds are not taxable, at least not most of the time. That’s because you’re taxed only on the capital gain from a sale, and you typically sell everything for less than you paid — in other words for a capital loss. Of course, if you start buying things cheap to sell for a profit at rummage sales, you would owe taxes on the net profit.

You can sell larger items on Craigslist or at a pawn shop. As long as you sell for less than you paid, no tax is due. So selling your stuff is a great way to quickly raise money without worrying about taxes. But of course, this is a limited income; you’ll run out of stuff at some point.

3. Credit Card Bonuses and Cash-Back

Although the law may soon change, for now your credit card rewards and cash-back are not considered taxable income. The reasoning is that when you get cash-back or points toward rewards for using your credit cards, you effectively just get a discount or rebate on the purchase price of whatever you buy.

The same has been true (so far) for credit card signup bonuses. Bank account signup bonuses are taxable as interest, but credit card bonuses usually require you to spend a certain amount on the card, and so are, once again, treated as a rebate on purchases.

There is an exception, which is rewards earned on business activity. If you’re claiming a purchase as a business expense and you earn rewards, you can really only claim the expense at the true cost; the price paid minus the rewards received. So, effectively, you pay tax on that cash back or those airline miles if earned from business activity.

4. The Profit From Selling Your Home

You may not know it if you haven’t sold your home in a while, or if you sold at a loss, but you don’t have to pay taxes on your capital gain. You can read all the rules on the IRS website, but here are the highlights:

  • You have to have lived in the home for at least 2 of the last 5 years
  • A gain of up to $250,00 can be excluded from taxable income
  • The exclusion is per person (so it’s $500,000 for a married couple)

Sell your home to make some tax free money? Why not? My wife and I have benefitted from this  tax code provision several times.

Of course, if, once you sell, you just buy a more expensive home, you haven’t gained anything. So how do you keep and use the tax-free gain? There are two ways.

One is to downsize, at least in terms of price. When we sold our Florida condo for $112,000, we made a profit of $16,000, and bought a larger house for $65,000. We sold that for $85,000 and now we live in a condo for which we paid $55,000 (and in-between there was a duplex we lived in, for which we got a partial exclusion).

The other strategy is to do what we did, but more purposefully. Specifically, you can buy and live in fixer-uppers to renovate them and make profit. Just stay at least two years in each and you’ll never owe taxes on the capital gains.

5. Children’s Paychecks

If you have a small business and are a sole proprietor your kids can get tax-free income. As long as they’re under the age of 18 you’re allowed to hire them without paying Social Security or Medicare taxes. Their wages are also free of income tax up to $6,300 per year thanks to the standard deduction.

Okay, that’s nice for the kids, but this is supposed to be about how you can make tax free income, right? Well, if you approach it the right way, that’s effectively what you get.

Think of all the things you buy for your children that they can buy for themselves once they have a paycheck. In the end it may appear to be the same whether you pay for things or you give the money to them and they pay, but done the second way the income that bought those things (your income) was never taxed.

6. Municipal Bond Income

Income from municipal bonds is tax free at the federal level, and generally at the state level if the bonds were issued in the state where you live. And this is not just a tax-avoidance strategy for the wealthy, After all, you have to put your meager savings somewhere, and those municipal bonds probably pay more than the bank.

Also, you don’t have to have big money to buy bonds. You can invest as little as $250 in some mutual funds that invest in “munis.”

Check a list of municipal bond funds to find those that are specific to your state so you won’t have to pay federal or state income tax.

If you have a stock trading account you might do even better, because you can buy closed-end funds at a discount. When you buy a closed-end municipal bond fund at a steep discount you effectively boost the rate at which you earn tax-free income, and you can buy as many or as few shares as you can afford.

7. Bottle and Can Deposit Refunds

Ten states have “bottle bills,” which are laws that require a refundable deposit on beverage containers. The specifics vary by state but, for example, most of them have a deposit of 5 cents on each beer or soda can or bottle.

Now, you might be thinking this isn’t “income” because you paid the deposit and you simply get it back. But that’s if you only return your own bottles and cans. If you gather them up from the garages of friends and families, it’s pure profit. I used to do that regularly when I lived closer to my family in Michigan, where the deposit is 10 cents per beverage container.

I assume the IRS would see this as a gift to you, and so the income would fall under the gift tax exclusion. Hitting the $14,000 limit on that is not too likely just from deposit refunds, although I did once made more than $1,000 in a year from cans collected in an employer breakroom (my co-workers drank soda endlessly and there was a soda machine in the room).

Note: It’s just my guess as to the IRS stance (ask a tax professional to be sure). I found nothing about the issue in my research. But don’t worry too much; if you collect $5.00 on 50 beer cans you gathered from your dad’s garage, I won’t mention it to the IRS if you don’t.

8. Reimbursements From Your Employer

If you pay for something related to your job, and your employer pays you back for the expense, these reimbursements are often not taxable.

This equates to tax-free income if you can convince your boss to reimburse you for things you’ would otherwise pay for anyhow. For example, if you’re taking classes to learn something that related to your job, ask the boss to reimburse you. For him it’s cheaper than giving you a raise, because he doesn’t have to pay payroll taxes on the reimbursement. For you it’s income that won’t be taxed.

There aren’t too many ways to swing this, but maybe you can find a few expenses for which you can ask to be reimbursed. Do you buy special clothing that’s needed for the job? How about tools? Licensing or professional fees you pay could be reimbursed too. Get advice from a tax professional if you’re not sure about a specific reimbursement.

9. Rental Income From Your Home

Generally if you rent your home out you have to pay taxes on the income. But the IRS says, “There’s a special rule if you use a dwelling unit as a residence and rent it for fewer than 15 days. In this case, don’t report any of the rental income and don’t deduct any expenses as rental expenses.”

In other words, keep it to 2 weeks or less each year and you owe nothing. You can use Airbnb to rent out all or part of your home by the night or week. If you live in an area with high demand during festivals or other events, you might get as much as $100 per night for a bedroom. In that case you could collect $1,400 tax free each year.

10. Non-Cash Payments That Replace Expenses

Anytime you get a non-monetary non-taxable benefit that replaces an expense you would otherwise still have, it’s effectively tax-free income. For example, if you work at a grocery store and your employer let’s you take home food that’s close to the expiration date, you’re basically making whatever you would have otherwise spent for that amount of groceries, but you don’t pay taxes on this “gift.”

Another example is if you live rent-free by house sitting. If that replaces $800 per month that you would otherwise pay for an apartment, you’re effectively making $800 per month. Whether you’re supposed to report the value of your free rent as income is a gray area. I found nothing in my research about it, but you might want to ask a tax professional if you’ll be doing a lot of house sitting.

Of course, if you also get paid money to take care of a house, that income is taxable, and the IRS is probably more likely to also consider the value of the free rent as taxable.

Housing provided by your employer as a fringe benefit is taxable as though you received the market rental rate as income. But employer-provided housing often isn’t taxed if it’s for your convenience and you’re required to utilize it as a condition of employment (ask a tax professional to be sure).

For example, company housing at a remote site where other housing isn’t available would not be taxable. Another example would be living in a cabin rent-free when it’s required for your duties as a park ranger.

If you know of another source of tax-free income (legal only, please), share it below… and keep on frugaling!

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