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12 Types of Tax-Free Passive Income

Today, as 'Your tax friend,' I want to educate you on a topic that many people overlook and should learn to improve their tax filings. Let's first define passive income: these encompass activities that generate economic benefits without the need to perform any specific type of work, while active income is the money obtained from some work done, which, in turn, has involved physical and/or mental effort.

There are numerous ways to generate passive income, but unfortunately, most of them are subject to taxes. This is particularly true in the case of income-generating investments, of which only a few allow you to avoid tax payments.

However, there are some credits, settlements, and payments that you can receive tax-free, although they are generally paid annually or as one-time occurrences. Here's a look at some types of passive income that are not subject to taxes.

Tax-Free Municipal Bonds

La forma más fácil, y de hecho, una de las únicas, de generar ingresos libres de impuestos a partir de susinversiones es comprar bonos municipales. Generalmente, los bonos municipales están libres deimpuestos a nivel federal. Los residentes del mismo estado que el emisor también suelen disfrutar deuna exención fiscal a nivel estatal. Sin embargo, las ganancias de capital, si corresponde, están totalmente sujetas a impuestos.

Inheritance

You won't have to worry about paying federal taxes on the inheritances you receive, no matter how large they may be. In some cases, the deceased may have to pay estate taxes, but that's not a concern for the beneficiaries. However, six states impose inheritance taxes on recipients, so you'll need to check if all your income is entirely tax-free.

Income from life insurance

If you are the designated beneficiary of a life insurance policy, your income will be paid to you income-tax-free. This holds true even if you receive a very large policy, such as $1 million or more. Keep in mind that if you cash in a life insurance policy, rather than receiving the proceeds from a death benefit, you may be required to pay taxes on a portion or all of the amount

Disability payments

In some cases, disability payments may be considered taxable income. However, if you pay all the premiums for a health or accident insurance plan, the disability payments you receive are not considered taxable income.

Gifts

Gifts can sometimes be subject to taxes for the donor if they exceed the annual gift tax exclusion level, which is $17,000 per person for 2023. However, recipients of gifts never have to pay taxes on what they receive.

Alimony

Alimony was previously deductible for the payer and taxable for the recipient, but all that changed in 2019. After January 1 of that year, payers could no longer deduct their alimony payments, and recipients no longer had to pay taxes on them. Note, however, that some states, such as California, do not follow this federal change and still tax alimony.

Child support

According to the IRS, just like with alimony payments, child support payments are not deductible for the payer nor taxable for the recipient.

Withdrawals from Roth IRA accounts

Roth IRA accounts differ from traditional IRA accounts in that distributions from them are generally tax-free. As long as your withdrawals are 'qualified,' which typically means you've had the account for at least five years and are over 59.5 years old, you won't have to pay taxes on the money you withdraw, even if it comes from interest or capital gains.

Disaster Mitigation Payments

If you experience a disaster, your state or local government may provide you with a disaster mitigation payment. These payments are not considered taxable income.

Qualified Adoption Reimbursements

In addition to receiving a tax credit for qualified adoption expenses, you can also exclude from income adoption assistance payments provided by the employer.

Qualified HSA Distribution

You are allowed to make a one-time distribution from your IRA to an HSA account without having to pay taxes on that transfer.

Income in a state without income tax

Currently, eight states do not tax income that is typically subject to federal taxes: Alaska, South Dakota, Nevada, Florida, Texas, Wyoming, Washington, and Tennessee. This is one of the few examples where regular taxable income is not subject to state income tax. However, you will still have to pay federal taxes on your income, even if you live in a state without income tax.

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