What Is an Income Exclusion Rule?

Income Exclusion Rules Explained in Less than 4 Minutes

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An income exclusion rule can apply to a wide range of tax rules that allow taxpayers to exclude certain types of income when calculating what they owe tax on. The exact types of income that can be excluded can depend on a taxpayer’s circumstances, but a common category includes payments made to individuals by the government for social benefit programs.

Learn more about how income exclusion rules work and which ones may apply to you.

Definition and Examples of Income Exclusion Rules

In general, an income exclusion rule applies to laws or policies that let taxpayers not count certain types of payments as taxable income. There is no single income exclusion rule per se, because there can be different types of income exclusion regulations in place among different tax authorities, such as state tax departments and the Internal Revenue Service (IRS).

Perhaps the most common income exclusion rule is the foreign earned income exclusion. This allows a U.S. citizen to avoid paying taxes on foreign earned income if they meet certain requirements, such as being a resident of another country for an entire tax year.

The general welfare exclusion, on the other hand, might be used to allow welfare recipients or those receiving other government assistance such as disaster relief payments to avoid having to pay taxes on these amounts.

Tax laws can differ among different jurisdictions, such as how the federal government might tax Social Security income in some cases, while many states do not tax Social Security at all. Tax jurisdictions also might have rules in place to partially exclude some income rather than providing full exclusions. In the state of Georgia, for example, those 62 or older, or permanently and totally disabled regardless of age, may be able to exclude part of their retirement income, but not all.

How Do Income Exclusion Rules Work?

Income exclusion rules are a result of laws and policies implemented by tax jurisdictions that allow some types of income to be excluded from income taxes. With this rule, certain types of income are considered non-taxable.

For example, the U.S. Congress passed the Tribal General Welfare Exclusion Act of 2014, which allowed American Indian tribes and Alaska Native corporations to make payments to members without these payments counting as taxable income in many cases.

Some areas can also fall under an income exclusion rule even if it’s not related to a traditional form of compensation. For example, Olympic medal winners could previously be subject to income tax, not just for cash prize money but also based on the value of the medals themselves. In 2016, however, the U.S. amended the tax code to exclude Olympic and Paralympic medals and prizes from taxable income for athletes with an adjusted gross income of up to $1 million.

Keep in mind that even if some money can be excluded from taxable income, taxpayers still might have to report certain earnings on their tax returns. This will depend on the rule at hand. That’s not to say all income reported on a tax return is taxed—or at least taxed in full—but it still might need to be disclosed.

Income Exclusion Rules and Social Security

The Supplemental Security Income (SSI) program from the Social Security Administration (SSA) is a needs-based program that benefits individuals over the age of 65 who meet certain financial limits, as well as disabled and blind individuals. The goal of the program is to pay for an individual’s most basic needs, such as food and shelter.

Some items that are considered income by the SSA are excluded when determining the amount an individual has to pay. Below, you’ll find exclusions broken down by unearned and earned income.

Principal Unearned Income Exclusions

The following can be excluded, per the income exclusion rule:

  • The first $20 received per month
  • Any income set aside to pursue a plan for achieving self-support, specifically by a disabled or blind individual
  • State or local aid based on need, fully funded by the state or local area
  • Rent subsidies under HUD programs and the value of supplemental nutrition assistance
  • The first $60 of irregularly received income in a quarter

Principal Earned Income Exclusions

  • The first $65 a month, and any unused portion of the $20 unearned income exclusion, plus one-half of the remainder
  • Impairment-related work expenses of a disabled individual, and work expenses of a blind individual
  • Any income set aside to pursue a plan for achieving self-support, specifically by a disabled or blind individual
  • The first $30 of irregularly received income in a quarter

What Do Income Exclusion Rules Mean for Individuals?

Individuals may want to research what counts as taxable and nontaxable income within the various tax jurisdictions they fall under, such as the federal and state levels.

If you know that some forms of compensation will be taxed based on your regular income tax rates, that can help you avoid overspending money you’ll eventually end up owing to tax authorities. On the other hand, if you know that other forms of compensation will be excluded from your taxable income, that may help you better plan for how to use that compensation in full.

In general, you don’t have to worry about memorizing every type of income that’s excluded or not excluded for federal, state, and local taxes. In many cases, tax software or qualified tax professionals will help you properly report and pay the tax you owe, taking into account compensation that can be excluded from your taxable income.

Key Takeaways

  • In general, an income exclusion rule applies to laws or policies that let taxpayers not count certain types of payments as taxable income.
  • An income exclusion rule can apply to many different types of laws, with one of the most common exclusion rules being the foreign earned income exclusion.
  • Excluded income can apply to categories such as Social Security benefit programs, as well as areas like disaster relief for welfare recipients.
  • Income exclusion rules can vary among different tax jurisdictions, such as how federal IRS rules might differ from state tax rules.