SUMMARY OF CHAPTER
Having just completed the study of gross income in the preceding chapter and thus gained a comprehension of
what income is and when it is taxable, the student should now be ready to proceed to the concepts underlying
exclusions from gross income, which are discussed in the present chapter.
Since gross income includes income from all sources, to be excluded from gross income the items must be
expressly exempted by law. Sections 101-139 list those items.
Common Exclusions from Gross Income
¶5001 Gifts and Inheritances
A gift, bequest, or inheritance is excluded from gross income. Thus, the donor does not receive a tax
deduction for the property transmitted. If property received by gift or inheritance later produces income, the
income is taxable.
¶5015 Life Insurance Proceeds
Generally, life insurance proceeds received by the beneficiary are not included in gross income if such
amounts are paid by reason of death of the insured. It is immaterial who the beneficiary is or whether the policy
was part of a group life insurance plan or was individually purchased. However, if payment is delayed and the total
amount when received includes interest, the interest is taxable.
¶5025 Sale of Residence
Sales of principal residences on May 7, 1997, and thereafter are eligible for a $500,000 exclusion from gross
income ($250,000 for single individuals). A two-year ownership and occupancy test and a two-year frequency test
must be met to qualify for the exclusion.
¶5035 Recovery of Tax Benefit Items
Gross income includes amounts received that were part of an earlier year deduction or credit. This is
considered a recovery and generally must be included in gross income in the year received.
¶5055 Retirement Income
A portion of the Social Security benefits or railroad retirement benefits must be included in taxable income for
taxpayers whose modified adjusted gross income exceeds a base of $25,000 for a single taxpayer ($32,000 for a
married taxpayer filing a joint return and zero for a married person filing a separate return). The Revenue
Reconciliation Act of 1993 added a second threshold for taxpayers whose provisional income exceeds $34,000
($44,000 for a married taxpayer filing a joint return and zero for a married person filing a separate return).
¶5075 Interest on Government Obligations
Interest earned on U.S. savings bonds is fully taxable. On Series EE bonds, no interest per se is paid each year,
but the bond is issued at a discount and each year increases in value until maturity. The difference between the
purchase price of the bond and the redemption value is taxable interest income. For tax years after 1989, a tax
exemption is provided for interest earned on U.S. savings bonds used to finance the higher education of the
taxpayer, the taxpayer’s spouse, or dependents. Interest received on state and local government bonds is generally
excludable from gross income.