Income exclusion rule definition

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What is the Income Exclusion Rule?

The income exclusion rule specifies that certain types of income are not to be included in a taxpayer's reported gross income for the purpose of calculating income tax. This means that excluded income is not reported on a taxpayer’s Form 1040. The types of income that can be excluded from reportable income include the following:

  • Annuity and pension payments that constitute returns of capital

  • Child support payments

  • Interest earned on municipal securities

  • Life insurance proceeds

  • Welfare payments

These income types are generally intended to provide tax relief to certain low-income taxpayers, though others were included as the result of lobbying efforts (such as the interest earned on municipal securities). With the exception of the interest earned on municipal securities, there is no limit on the types of income that fall within this rule. The interest on municipal securities is added back to the gross income figure in order to calculate alternative minimum tax.

This rule is promulgated by the Internal Revenue Service.