Tax Exclusions Explained

Exclusions are not deductions

An exclusion keeps an amount out of gross income. You never get to deduct it later, and some exclusions require a form even when no tax is due. Mixing them up is how people miss Form 2555, overstate the home-sale exclusion, or treat a taxable disability payment as tax-free.

Common exclusions that still hold in 2026

• Gifts and inheritances received (the donor or estate may owe tax; the recipient usually does not)
• Life insurance death benefits
• Municipal bond interest (often taxable at the state level if the bonds are out-of-state)
• Workers’ compensation
• Employer-paid health coverage and qualified HSA distributions for medical expenses
• Scholarships used for qualified tuition and required fees, not room and board

Dollar limits that changed

• Foreign earned income exclusion: $132,900 per qualifying person for tax year 2026 ($130,000 for 2025). Claimed on Form 2555. Housing exclusion/deduction is separate and location-based.
• Home sale exclusion: still $250,000 ($500,000 joint) of gain if you meet the ownership and use tests. Depreciation taken after May 6, 1997 is not excluded.
• Adoption assistance exclusion: follows the 2026 adoption credit limit of $17,670 of qualified benefits from an employer plan.

Reporting still required

Excluded income can still affect MAGI for credits, IRMAA, and the SALT cap. Foreign earned income that you exclude cannot also generate a foreign tax credit on the same dollars. If you live abroad, run FEIE vs. foreign tax credit before you lock in Form 2555 — revoking the election generally locks you out for five years.