1. 8 types of income the IRS can't touch
Tax-free interest
Interest earned on bonds issued by a state, territory, municipality or any
political subdivision is free from federal taxes. These are generically called
municipal bonds, and their tax benefit increases in value as your marginal
tax rate goes higher. (In other words, the bonds are worth more to you as
your overall income rises.)
Assume you're in the 35% bracket, the top rate through the 2011 tax year.
A 5% tax-free rate becomes the equivalent of a taxable rate of 7.69%. In
the 15% bracket, the taxable equivalent is only 5.88%. Go here on the site
InvestingInBonds.com to compare taxable and tax-free yields. You can also
find the after-tax rates on alternative investments of equivalent risk.
Some bonds may not only be tax-free at the federal level, but may also
escape state and local taxes. If you're in a top bracket and live in New York
City, this is one investment you definitely want to consider for your portfolio.
Carpool reimbursements
Commuting to work? Bring a friend -- and his wallet. If you form a carpool
to carry passengers to and from work, any payment received from these
passengers isn't included in your income.
Commuting costs are generally not deductible. But if you establish a
carpool and you're reimbursed in amounts sufficient to cover the cost of
your repairs, gas and similar items used in connection with operating your

2. car to and from work, then you've converted personal nondeductible
expenses into excludable income.
Assume you're in the 25% bracket for 2011. You have to earn $133 per
month to cover a $100 monthly commuting expense. If you have a carpool
arrangement with expenses being reimbursed, you've got no additional
income -- but you do have an additional $133 per month in wealth.
Profit from selling your house
Under a tax law enacted in 1997, if your house was your principal
residence for two of the most recent five years, you can exclude as much
as $250,000 in gain ($500,000 on a joint return) when you sell it.
You don't have to reinvest the money, and you can claim the exclusion
every two years. (If you've got $500,000 in gain every two years, I want to
meet your real-estate agent and go shopping!)
If you don't meet the two-year rule, you may be able to get a partial
exclusion based on the time of use and ownership.
Assume you sold after only one year and had a $50,000 profit. Your
exclusion is half the $250,000, not half the $50,000 profit. In this case,
you'd pay zero tax on the sale.
But this partial exclusion is valid only if the sale is required because of a
change in place of employment or for health reasons or unforeseen
circumstances. The IRS has been very flexible with "unforeseen
circumstances." Even the birth of twins or a neighbor's hostility qualifies.
Tax-free compensation: Health care
When you're due for a raise, ask your company to get creative in your
compensation. There are numerous ways to receive nontaxable
compensation. Let's look at some of the best alternatives to taxable earned
income. Any time you can convert taxable income into nontaxable income,
you've given yourself a raise. And when both you and your company save
money, it's a win-win situation.
For example, health coverage. Health and hospitalization insurance
premiums paid by your current or former employer are tax-free -- a huge
benefit. Let's say your health insurance premiums come to $280 a month,

3. or $3,360 a year (for an HMO policy for a family of four with a $1,500
deductible). If you're in the 25% tax bracket and have to pick up the bill, the
real cost to you would be $4,480. That's $3,360 for the premiums and
$1,120 for additional income taxes because you'll be paying for the
coverage in after-tax dollars. Having your company pick up the cost helps
both of you. Your employer doesn't have to pay the salary necessary to get
you even, and it gets to write off the full cost of the coverage. Plus, neither
of you has to pay the 7.65% payroll taxes (5.65% for 2011 through a
special credit) on the premiums. And you, of course, boost your disposable
income substantially.
Tax-free compensation: Cover your life
Group term-life insurance coverage of $50,000 or less paid for by your
company isn't taxed to you. You pick the beneficiary; your company pays
the premiums. Your company deducts the expense; you walk away with
additional tax-free income.
Tax-free compensation: Send yourself to school
Get educated. The courses don't even have to be job-related. But they
can't be for any education involving sports, games or hobbies. Your
company can pay, and deduct, as much as $5,250 per year in educational
assistance paid for either undergraduate or graduate courses. Again, that
assistance comes to you tax-free.
Tax-free compensation: Get yourself there . . . and parked
Your company can give you discount fare cards, passes or tokens to take
public transportation to work. As long as it is not worth more than $230 a
month, your company can deduct it, but you, as an employee, receive it
tax-free as a de minimis tax benefit. If you drive to work and have to pay for
parking, your company is now able to provide you free parking, up to a
maximum value of $230 a month, tax-free. Alternatively, your employer can
designate $20 per month of your pretax earnings for expenses relating to
commuting by bicycle.
Tax-free compensation: Cafeteria menu of benefits
These are sometimes called flexible spending accounts. Your company
makes deductible contributions under a written plan that allows you to

4. select between taxable and nontaxable benefits. To the extent you choose
nontaxable benefits, you have no additional income. Available nontaxable
benefits may include group life insurance, disability benefits, dependent
care and/or accident and health benefits. Your individual plan details the
options. You make your choices among the items on the cafeteria menu.
Note that 2010 was the last year you could use your flexible spending
account money for nonprescription drugs. Drug payments from such plans
are now limited to prescription drugs and insulin.