The Advantages of Nontaxable Income

The majority of earnings are taxed by the federal government. Many states also assess a state income tax. You are required to declare all income you receive through employment, self-employment or as an independent contractor. However, certain types of income are exempt from taxes. Not having to pay taxes on exempt income is a big advantage that can help you achieve your financial goals.

Nontaxable Sources of Income

There are a few sources of income exempt from taxes. Disability benefits, such as workers' compensation or compensation from an auto insurance company, are not taxed. Disability benefits from the federal government in the form of Social Security disability or Supplemental Security Income are exempt. Other examples include child support, public assistance benefits and life insurance payouts. If you sell your principal residence, the profit is exempt up to $250,000 for a single person and $500,000 for a couple.

More Money Immediately

The main advantage of receiving nontaxable income is not having to pay taxes on the money. It is never fun having to give Uncle Sam a portion of your earnings. By not having taxes withheld, you get to enjoy all your money now instead of waiting to receive a portion of it back on your tax return.

Opportunity to Invest More

By not having to pay taxes on the money you receive, you have more cash on hand now to invest for the future. You can build up your net worth by contributing a portion of your income to an interest-bearing account, such as an individual retirement account. Over time, your earnings can really add up as long as you are consistent. You can also explore over investment options, such as stocks, bonds, and certificates of deposit.

Lower Tax Bracket

A higher income typically places you in a higher tax bracket. Not having to declare the nontaxable income may help you stay in a lower bracket so your taxable income is taxed at a lower rate. Some sources of nontaxable income require you to report the earnings on your taxes if you exceed a certain amount. For those receiving Social Security benefits with an income between $25,000 and $34,000, up to 50 percent of benefits are taxable, as of 2012. The taxable portion of benefits can reach 85 percent for earnings over $34,000. For married couples filing a joint return and earning between $32,000 and $44,000, up to 50 percent of benefits are taxable. Earn over $44,000, and a couple pays taxes on up to 85 percent of benefits. In most cases, this applies to people who receive income in addition to Social Security retirements or disability benefits.