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A Surprising Look at What Income is Taxable—And What Isn’t

Jan. 14, 2022, 9:45 AM

Twitter lit up recently over a post reminding taxpayers to declare income from illegal activities. Some users couldn’t believe that it was real. But the declaration—which is not new—can be found in IRS Publication 17, which notes that “Income from illegal activities, such as money from dealing illegal drugs, must be included in your income...”

You’ll find the same language in IRS Publication 525.

The authority for the statement is found in tax code Section 61, which makes clear that “gross income means all income from whatever source derived” unless it’s otherwise excluded. That’s a pretty high bar—and the starting point of our entire tax system.

And even though it feels a bit odd to require taxpayers to report income earned from committing a crime, it’s a law that’s been confirmed in the courts. In U.S. v. Sullivan, the U.S. Supreme Court ruled that the fear of self-incrimination was no excuse to not report, with Justice Holmes writing, “We see no reason to doubt the interpretation of the Act, or any reason why the fact that a business is unlawful should exempt it from paying the taxes that if lawful it would have to pay.”

Sullivan would prove pivotal a few years later, when, in 1931, Al Capone was sentenced to prison for tax evasion. Capone, who made millions from bootleg liquor, gambling halls, and other crimes of the day, had reportedly boasted, “The government can’t collect legal taxes from illegal money.”

What’s Taxable?

Not sure what else you have to report? Here are four more possibly surprising sources of taxable income for federal tax purposes.

Found Money. If you find and keep property that doesn’t belong to you that has been lost or abandoned—sometimes referred to as “treasure trove"—the property is taxable to you. It’s taxable at fair market value in the first year that you establish ownership.

The rule has been on the books for decades. Rev.Rul. 61, 1953-1, Cum.Bull. 17 confirmed that “The finder of treasure-trove is in receipt of taxable income, for Federal income tax purposes, to the extent of its value in United States currency, for the taxable year in which it is reduced to undisputed possession.” The guidelines were officially tested in court in 1969 in Cesarini v. U.S.—today, found money is generally considered ordinary income.

Unemployment Compensation. All states offer benefits for unemployed persons who qualify. Benefits paid out under these plans are generally considered compensation for federal income tax purposes. That makes sense—unemployment benefits are considered a replacement for taxable wages.

Unemployment compensation is reported to taxpayers on Form 1099-G. If that form sounds familiar, Form 1099-G is used to report many types of government payments, including state tax refunds.

It was the case that for the tax year 2020, individuals with an adjusted gross income of less than $150,000 could exclude up to $10,200 of unemployment compensation from gross income. However, under current law there’s no exclusion, which means that unemployment compensation received in 2021—and 2022—is taxable.

Canceled Debt. Getting rid of debt by having it written off feels like a big win—but if your debt is canceled for less than the amount you owe, the amount of the canceled debt may be taxable. That means that you have to report the canceled debt as income unless an exclusion applies. The most common exclusions include bankruptcy, insolvency, and qualified principal residence indebtedness.

If your debt is discharged for less than what you owe—and that amount is $600 or more—you may receive Form 1099-C. This typically happens when the creditor determines that you cannot or will not pay what you owe. Examples include when you cut a deal with a credit card company to pay a reduced amount to close the account, or following a foreclosure or repossession. The difference between what you owe and what you pay is considered income—again, assuming that you don’t qualify for an exclusion.

Even if you qualify for an exclusion, you may still receive Form 1099-C, since the creditor may not know your circumstances. However, if the creditor has reason to know that the cancellation of debt would not be taxable—for example, due to bankruptcy—Form 1099-C shouldn’t be issued.

Lottery Winnings. Lottery winnings are treated like gambling winnings, which means that, for federal purposes, they’re taxed as ordinary income. That’s true whether you collect your payment as a lump sum or as an annuity. It’s also the case if you win a non-cash prize, like a car or house.

Winnings are typically reported on Form W-2G and are subject to withholding of 24% if the amount is more than $5,000. If you owe more in tax, you’ll pay the difference at tax time, and if you owe less, any overage will be refunded to you.

What’s Not Taxable?

So it turns out that a lot of things are taxable. But it isn’t all gloom and doom. Remember when I said that income is taxable unless it’s otherwise excluded? Those exclusions really do exist. Here are five examples of money that could land in your pocket that isn’t taxable.

Gifts and Inheritances. Property you receive as a gift or inheritance is not typically included in your taxable income. However, keep in mind that the tax characteristics of the gift or inheritance will generally remain in place. So if your dad gives you $100 of stock as a gift, the $100 is not taxable to you for federal purposes, but any dividends it throws off—or gains when sold—would be taxable. Some exceptions may apply—the SECURE Act, for example, has changed how retirement assets may be taxed after death.

Child Support. Child support is entirely tax-neutral, meaning that there’s no deduction for making the payment, and it isn’t taxable to the recipient.

Sale of your home. You can exclude the gain from the sale of your home—up to $250,000 for single taxpayers and $500,000 for married taxpayers—so long as you qualify. To be eligible, the home must be your primary residence, and you must have owned and lived in the home for two of the five years before the sale.

Life insurance. Life insurance proceeds paid after the insured person’s death generally aren’t taxable. However, as with gifts and inheritances, any tax characteristics associated with the proceeds remain in place—that means, for example, that interest income received due to life insurance proceeds may be taxable.

Short-term rental income. If you rent out your personal residence for less than 15 days in a year, you don’t need to report any of the rental income for federal income tax purposes—you also can’t deduct any corresponding rental expenses.

Keep in mind that this is meant to be a quick look at what’s taxable—and what’s not. The tax code is made up of over a million words—and that’s before adding in regulations and case law. There’s a lot of room for exceptions, exemptions, and nuance. If you have questions, it’s always a good idea to check with a tax professional.

This is a weekly column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest in tax news, tax law, and tax policy. Look for Erb’s column every week from Bloomberg Tax and follow her on Twitter at @taxgirl.

To contact the reporter on this story: Kelly Phillips Erb in Washington at

To contact the editors responsible for this story: Rachael Daigle at; Meg Shreve at