Exclusions From Income under Tax Law
Exclusions From Income – Tax Law Overview
Exclusions from income refer to specific types of income that the tax code explicitly removes from gross income. Under the Internal Revenue Code (IRC §61), gross income is defined broadly as “all income from whatever source derived.” However, certain items are excluded by law and are not subject to taxation.
⚖️ Key Legal Basis:
IRC §61 – Defines gross income broadly.
IRC §§101–140 – Lists various specific exclusions from gross income.
✅ Common Exclusions From Income (with Explanation and Case Law)
1. Gifts and Inheritances (IRC §102)
Rule:
Gifts, bequests, and inheritances are excluded from gross income.
Key Points:
A gift must be made from “detached and disinterested generosity.”
Income generated from the gift is taxable.
Case Law:
Commissioner v. Duberstein, 363 U.S. 278 (1960)
The Supreme Court clarified the standard for gifts: the intent of the donor is crucial. If the transfer is made out of detached generosity, it is a gift; if made for services rendered, it is compensation.
2. Life Insurance Proceeds (IRC §101)
Rule:
Amounts received under a life insurance contract due to the death of the insured are excluded.
Exception:
Interest earned on the proceeds is taxable.
Case Law:
Estate of Becker v. Commissioner, 40 T.C. 729 (1963)
Confirmed that life insurance proceeds paid by reason of the insured’s death are not includible in gross income.
3. Municipal Bond Interest (IRC §103)
Rule:
Interest on state or local bonds is excluded from gross income.
Purpose:
Encourages investment in public infrastructure by offering tax advantages.
Case Law:
Helvering v. Mountain Producers Corp., 303 U.S. 376 (1938)
Upheld exclusion for interest on tax-exempt securities issued by state and local governments.
4. Scholarships and Fellowships (IRC §117)
Rule:
Scholarships used for tuition, fees, books, and required supplies are excluded.
Limitation:
Amounts used for room, board, or services rendered (e.g., teaching) are taxable.
Case Law:
Commissioner v. Johnston, 55 T.C. 598 (1971)
Court found that scholarship stipends given in exchange for services (e.g., teaching) were compensation, not excluded scholarships.
5. Compensation for Injuries or Sickness (IRC §104)
Rule:
Amounts received through lawsuit or settlement due to personal physical injuries or sickness are excluded.
Limitations:
Does not apply to punitive damages, emotional distress not tied to physical injury, or employment-related back pay.
Case Law:
Commissioner v. Schleier, 515 U.S. 323 (1995)
Emotional distress and back pay under ADEA (Age Discrimination in Employment Act) were not excludable, as they were not based on physical injuries.
6. Qualified Employer-Provided Fringe Benefits (IRC §132)
Examples:
No-additional-cost services
Qualified employee discounts
Working condition fringe benefits
De minimis fringe benefits
Employer-provided parking or transit passes (within limits)
Purpose:
Recognizes non-cash benefits that are difficult to value and administer if taxed.
Case Law:
Tucker v. Commissioner, 69 T.C. 675 (1978)
The court allowed exclusion of employee-use airline passes as non-taxable fringe benefits.
7. Foreign Earned Income Exclusion (IRC §911)
Rule:
U.S. citizens or residents living abroad may exclude up to a certain amount (indexed yearly) of foreign earned income.
Requirements:
Taxpayer must have a foreign tax home and meet the bona fide residence or physical presence test.
Case Law:
Sochurek v. Commissioner, 300 F.2d 34 (7th Cir. 1962)
Defined criteria for bona fide residence abroad. The court held the taxpayer did qualify based on facts and circumstances.
8. Welfare and Public Assistance Payments
Rule:
Public welfare benefits such as TANF, food stamps, and housing assistance are excluded.
Rationale:
These are considered governmental transfers for public welfare, not compensation.
Case Law:
Not typically litigated as the law clearly excludes these.
9. Discharge of Indebtedness (IRC §108) – Limited Exclusion
Rule:
Cancellation of debt may be excluded if:
Taxpayer is insolvent
Debt is discharged in bankruptcy
Qualified principal residence indebtedness (limited)
Case Law:
Zarin v. Commissioner, 916 F.2d 110 (3rd Cir. 1990)
Court ruled that disputed gambling debts settled for less than full value were not taxable cancellation of indebtedness income.
🧾 Summary Table
| Exclusion Type | IRC Section | Key Limitation / Notes |
|---|---|---|
| Gifts & Inheritances | §102 | Must be genuine gift; income from gift is taxable |
| Life Insurance Proceeds | §101 | Interest on proceeds is taxable |
| Municipal Bond Interest | §103 | Only applies to state/local bonds |
| Scholarships | §117 | Room/board and service-based aid are taxable |
| Injury/Sickness Damages | §104 | Only for physical injuries |
| Fringe Benefits | §132 | Must meet qualified criteria |
| Foreign Earned Income | §911 | Must meet residence/physical test |
| Welfare Benefits | - | Generally excluded if from public assistance |
| Discharge of Debt | §108 | Only excluded in insolvency/bankruptcy, etc. |
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