Intuit Academy Tax Practice Exam

What does Tax Exempt Income represent on a taxpayer's return?

1. Income that reduces taxable income

2. Income that is not subject to federal income tax

3. Income that must be reported as gross income

4. Income that is excluded from social security calculations

The correct answer is: Income that is not subject to federal income tax

Tax Exempt Income refers to income types that are explicitly not subject to federal income tax. This means that while the taxpayer may receive this income, it does not contribute to their taxable income for federal tax purposes. Examples of tax-exempt income include certain types of interest income from municipal bonds, life insurance proceeds, and certain gifts or inheritances. In contrast, the other options do not accurately reflect the nature of tax-exempt income. For instance, income that reduces taxable income generally indicates deductions or exclusions that lower the taxable base, rather than income that is simply exempt. Additionally, all gross income, regardless of its tax status, must still be reported by taxpayers, so not all income can be excluded from reporting. Lastly, while some forms of income may influence social security calculations, tax-exempt income inherently refers to its exempt status from federal income taxes, making that option less pertinent to the definition of tax-exempt income.