There are numerous ways to earn passive income, but unfortunately, most of them are taxable. This is particularly true of income-generating investments, of which only a handful allow you to avoid paying tax.
However, there are some credits, settlements and payouts that you can receive tax-free, although these are typically paid either annually or a single time. Here’s a look at some of the types of passive income that aren’t taxable.
Tax free passive income
- Tax free municipal bonds
- Inheritance
- Life insurance proceeds
- Disability payments
- Gifts
- Alimony
- Child support
- Roth IRA withdrawals
- Disaster mitigation payments
- Qualifying adoption reimbursement
- Qualified HSA disbursement
- State income with no state tax.
Tax-Free Municipal Bonds
Buying municipal bonds is the easiest and one of the only ways to make money from your investments without paying taxes. Most municipal bonds are not taxed by the federal government. Most of the time, people who live in the same state as the issuer get a tax break at the state level as well. But, if they happen, capital gains are fully taxed.
Inheritance
No matter how much of an inheritance you get, you won't have to worry about paying federal tax on it. In some cases, the person who died may have to pay estate taxes, but beneficiaries don't have to worry about that. However, there is an inheritance tax in six states, so you'll need to check to see if all of your money is tax-free.
Life Insurance Proceeds
If you are named as the beneficiary of a life insurance policy (except for a foreign life insurance policy), you won't have to pay income tax on the money. This is true even if your policy is worth a million dollars or more. Note that if you cash in a life insurance policy instead of getting the death benefit, you may have to pay taxes on some or all of the money.
Disability Payments
In some situations, disability payments can be counted as income that needs to be taxed. But if you pay all of the premiums for a health or accident insurance plan, any disability payments you get are not taxed.
Gifts
The person who gives the gift may have to pay taxes on it if it is worth more than the annual exclusion amount, which is $17,000 per person in 2023. But people who get gifts don't have to pay tax on what they get.
Alimony
Before 2019, the person who paid alimony could write it off and the person who got it had to pay taxes on it. After January 1 of that year, people who paid alimony could no longer deduct it, and people who got it no longer had to pay tax on it. But keep in mind that some states, like California, do not follow this change at the federal level and still tax alimony.
Child Support
According to the IRS, child support payments are the same as alimony payments in that neither the person paying nor the person getting the money has to pay taxes on it.
Roth IRA Withdrawals
The money you take out of a Roth IRA is usually tax-free, which is different from a traditional IRA. As long as your withdrawals are "qualifying," which usually means you've had the account for at least five years and are older than 59.5, you won't have to pay taxes on any money you take out, even if it comes from interest or capital gains.
Disaster Mitigation Payments
If you are affected by a disaster, your state or local government may give you a payment to help you recover. These payments do not count as income for tax purposes.
Qualifying Adoption Reimbursements
You can get a tax credit for qualified adoption costs, and you can also leave out of your income any adoption assistance payments from your employer.
Qualified HSA Funding Distribution
You can move money from your IRA to your HSA account one time without having to pay taxes on that money.
Income in a State With No Income Tax
At the moment, only Alaska, South Dakota, Nevada, Florida, Texas, Wyoming, Washington, and Tennessee do not tax income that is usually taxed at the federal level. This is one of the few times when regular income that is usually taxed is not taxed. Even if you live in a state with no income tax, you still have to pay federal taxes on your income.
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