Seven Checks You Can Cash Free of Federal Income Tax
by Apr 15th 2011 11:00AM
Ronald Reagan once famously remarked that the government's take on the economy was, "If it moves, tax it." At tax time, it can feel as though that's true.Realistically, though, not every dollar you receive is taxable (even though in some circumstances, it may still be reportable). Following are seven checks that you can cash, federal income tax free:1. Life insurance proceeds. Life insurance proceeds might be taxable for federal estate tax purposes, but when it comes to federal income tax, most life insurance contracts are income tax free. The general rule is that life insurance proceeds paid to you as a pure death benefit are not taxable; this is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. The "regular" income rules still apply, however, so that interest on the proceeds may be taxable.
2. Cash gifts. If you're lucky enough to get a cash (or cash equivalent) gift -- no matter the amount -- you can spend it all without paying Uncle Sam. While the person who gave the gift to you might be subject to federal gift tax on the gift, there is no income tax on the gift when you receive it.
3. Roth IRA withdrawals. With a traditional IRA, you get the benefit of income tax deferral on contributions made during your lifetime, but when you withdraw the money, you pay federal income tax. However, it's different with a Roth IRA. You pay the tax on the money contributed to the Roth IRA upfront. That means when you take it out, you don't pay federal income tax on the withdrawals, no matter how much it has grown.
4. Child support. Unlike alimony, which has federal income tax consequences, child support is tax neutral. There's no deduction available to the person paying the support, and there's no income recognized when a person receives child support.
5. Return of capital. We all know that interest and dividends inside of a traditional brokerage account (or other investment account) are generally taxable. But what about money you withdraw from the account that you contributed in the first place? While the dividends and interest are taxable and growth on the initial contribution might be subject to capital gains, the initial contribution can be withdrawn without triggering federal income tax. An investment of capital, no matter what the form, is generally returned to you, federal income tax free.
6. Federal income tax refunds. If you received a state tax refund in 2010, chances are that you also received a form 1099-G to report the refund. While state tax refunds may be taxable to you for federal income tax purposes, federal income tax refunds are not taxable -- whether it's a mere dollar or $54,000.
7. Making Work Pay Credit. The Making Work Pay Credit makes its final appearance for the 2010 tax year (it's been replaced in 2011 by the payroll tax credit). If you received the credit in 2009, it does not affect your 2010 tax return (eligibility for the credit in one year doesn't affect eligibility for the credit in another year). Additionally, the credit is not taxable to you for federal income tax purposes.
A quick reminder: These rules apply to federal income tax only. There may be different rules for your state or local taxing authorities, and other taxes, such as federal estate and gift tax, might also be relevant.
