What is an example of a tax-exempt income?

Interest from tax-free municipal bonds is a prime example of tax-exempt income because the Internal Revenue Code specifically provides that interest earned on municipal bond investments is not subject to federal income tax. These bonds are issued by state and local governments to fund public projects, and their tax-exempt status is designed to encourage investment in community-based initiatives.

This tax benefit is an important consideration for investors, as it can enhance the after-tax return on their investments compared to taxable bonds. Tax-free municipal bonds also often attract those in higher tax brackets who may be seeking to reduce their overall tax liability while still earning interest income.

Other choices, while relevant to tax situations, do not fall under the classification of tax-exempt income. High-deductible health plan benefits generally involve pre-tax contributions or tax-free withdrawals for qualified medical expenses, but they aren't classified as income. Similarly, gains from the sale of real estate could be taxable depending on various factors such as ownership period and profit limits; therefore, they aren't universally tax-exempt. Pensions from employer-sponsored plans are typically taxed as ordinary income when distributions are taken, thus they also do not qualify as tax-exempt income.