Tax free is a term that refers to any activity or asset that goes untaxed. The term is typically applied to assets or activities that would normally be taxed, but are granted special tax-free status for one reason or another.
Sales Taxes and Tax Free Holidays
Five states – Alaska, Delaware, Montana, New Hampshire and Oregon -- levy no statewide sales taxes.
Several other states and the District of Columbia offer sales tax holidays, which are specific times of the year during which some or all sales are exempt from tax. For example, in 2009, Texas exempts most clothing from sales taxes for a week in August to help families with back-to-school expenses (although a broad list of sportswear and clothing accessories are still taxed.) New York exempts shoppers from the state’s 4 percent sales tax year-round for clothing and shoe purchases of less than $110, while Washington, D.C., exempts small clothing, shoe and accessory purchases for a week in August and a week during the winter holiday season.
Income Tax Free States
Seven states – Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming – levy no state income taxes. New Hampshire and Tennessee limit their state income taxes to dividends and interest income only, leaving wages tax free.
Tax Free Municipal Bonds
Municipal bonds are debts issued by state and local governments to raise money for everything from government operations to the running of hospitals, stadiums and other specific projects. Due to constitutional rules on the separation of powers between the states and the federal government, the interest paid on municipal bonds is generally exempt from federal taxes (although some types of municipal bond interest might be subject to the federal Alternative Minimum Tax). If the investor who owns the bonds also lives within the jurisdiction that issued them, the interest is usually exempt from state and local income taxes as well.
Because municipal bonds are tax-free, or very close to it, they can generally pay lower interest rates than corporations whose bond interest is fully taxable.
Tax Free Roth Accounts
Roths are types of personal retirement accounts that are granted special tax benefits by federal law. Money put into a Roth IRA or a Roth 401(k) is taxed as income in the year in which it goes in. After that, the account's investment growth is completely tax free, even when it is withdrawn in retirement.
Most other types of retirement accounts, including traditional 401(k)s and IRAs, are considered tax-deferred, which means that money can go in and grow without tax, but income taxes are owed when it is withdrawn.
There are a variety of Roths:
- Roth IRAs have relatively low annual contribution limits. Anyone can open a Roth IRA, but contributors who make more than a certain amount of income in any given year are prohibited from contributing.
- Roth 401(k)s have much higher annual contribution limits, but can only be established by an employer.
- Self-employed Roth 401(k)s have the highest annual contribution limits, but are available only to business owners with no employees other than their spouse.
Duty Free
Duty free shops offer goods free of some, if not all, local taxes. Duty free shops in Europe, for example, offer goods free of local import taxes and free of the value added tax that most European countries assess on goods sold within their borders.
Duty free sales are available on international flights and in special duty free shops at some border crossings and international airports.
Buying goods in a duty free store does not relieve travelers from complying with any limits their destination country might place on the allowable dollar value of goods brought into the country by individuals. Violating such provisions could result in additional fees, or in the confiscation of the items at the border.
Life Insurance
Money spent on life insurance premiums is generally taxed as income, but life insurance benefits that are paid out to heirs are almost always tax free.
Life insurance is generally intended to provide the dependents of a key breadwinner with cash in the event of the breadwinner’s untimely demise, but the tax-free benefit can make it an attractive investment and estate planning tool for some high-income families.
Related Resources on Tax Free
About.com Banking/Loans: Roth 401k - Overview of Roth 401k Plan Provisions [1] About.com Banking/Loans: Roth 401k Pitfalls - Disadvantages of Roth 401k Plans [2] About.com Bonds: Should I Buy a Muni Bond? Only Your Tax Accountant Knows for Sure [3] About.com Bonds: Supreme Court Protects Muni Bonds' Tax Status [4] About.com Budget Travel: Is Duty Free a Good Deal? [5] About.com Canada Travel: Duty Free Shopping at the Canadian Border - What Visitors Can Buy at Duty Free [6] About.com Financial Planning: Planning For the Future - Making the Most of Your Retirement [7] About.Com Financial Planning: Roth IRAs Offer Flexibility and Tax-Free Returns [8] About.com Germany Travel: New Duty-Free Rules [9] About.com Investing for Beginners: Are Municipal Bonds Right For You? [10] About.com Investing for Beginners: Investing in Life Insurance [11] About.com Investing for Beginners: Investing in Municipal Bonds [12] About.com Investing for Beginners: Roth 401k [13] About.com Investing for Beginners: Self-Employed 401k [14] About.com Single Parents: 2009 Tax Free Weekend Events [15] About.com Single Parents: New York's Tax Free Shopping Dates [16] About.com Stocks: Bonds and Taxes [17] About.com United Kingdom Travel: Duty Free Allowances Double in Time for the Holidays [18] Ask Yahoo!: How Many States Are Tax Free? [19] CNN.com: What’s the Deal With Duty Free Shopping? [20] District of Columia, Office of Tax and Revenue: Shop DC Tax Free [21] Federation of Tax Administrators: State Income Tax Table [22] International Business Times: How Do 'Build America Bonds' Work? [23] Investopedia: The Basics of Municipal Bonds [24] MSN Money: The Best and Worst States For Taxes [25] MunicipalBonds.com: Information on Municipal Bonds from All 50 States [26] New York State Department of Taxation and Finance: Year-Round Sales and Use Tax Exemption of Clothing, Footwear, and Items Used to Make or Repair Exempt Clothing [27] North Carolina Department of Revenue: August Sales Tax Holiday [28] North Carolina Department of Revenue: List of Items Exempt During The Sales Tax Holiday [29] NY Daily News: Duty Free Shopping Is Not Always A Good Deal [30] The Sales Tax Clearinghouse: Online Sales Tax Calculator [31] Window on State Government: Texas Clothing Sales Tax Holiday [32]