Exempt income refers to any income that is exempt from taxation. The rules and regulations that govern exempt income vary from country to country – and even by locale within a country. However, they are created as different types of incentives and breaks to foster certain types of growth and economic well-being.
Different types of income can be exempt, partially exempt, or non-exempt. It is an important distinction to make when preparing a tax return and understanding how to operate a small or large business. Understanding exempt income rules can allow one to legally and accurately optimize these taxation benefits.
Exempt income is income that is accrued from a source that is exempt from taxation.
Different types of income can be exempt, partially exempt, or non-exempt.
Some examples include lottery winnings in Canada, foreign earned income, and some types of gifts.
Examples of Exempt Income
The list below provides some examples of different types of exempt income. It is important to note, however, that the exemptions are regionally based and may not apply where you live. It is best to consult your local and federal tax code to understand exactly which tax exemptions apply to you.
Employment insurance benefits
Gifts – nonrecurring and generally under $900-$1000
Lottery winnings (Canada)
Income earned internationally (outside the taxation zone)
Exempt Foreign Income
Individuals who receive income from a foreign country may get some or all that income exempt. It depends on a number of factors, such as the country from which the income originates, the type of income it is, how much income is earned, and whether it had been subject to taxes in that country..
In Canada, when declaring exempt foreign income, it must be declared on your tax return. It must be noted the country the funds came from, as well as the entire amount of income before any foreign tax. A separate form for each country in which you’ve received income must be filled out.
If a tax treaty exists between the country upon which the income was gained and Canada, a special section on the Canadian tax return exists to make this income exempt. All different types of income from these countries may be taxed differently.
For example, pension and income tax gained in a treaty country may be regarded as different and exempted differently. Countries that have applicable tax treaties can be found on the government of Canada’s Department of Finance website.
One common example of such an occurrence is the U.S. Social Security benefits that are paid to individuals who are now residing in Canada. As of 2020, in Canada, you may claim up to 15% of those benefits on your tax return as tax-exempt income.
Special Economic Zones
Often, countries will set up special economic zones to spur innovation and development. They serve as a type of incubator for new and existing companies to grow in close relation to one another in circumstances conducive to their success.
Many times, certain types of income exemption make it lucrative and appealing for talented individuals to earn and relocate to the special economic zones. Many developing countries offer such incentives in their ports as well, whereby exporters of certain goods abroad will often be exempt from income tax and certain types of duties.
CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: