The federal government, state agencies and local governments issue welfare benefits to needy individuals and families. These benefits come in the form of Temporary Assistance for Needy Families (TANF) payments, food stamps and heating assistance. Unlike other forms of income, welfare and government assistance payments are subject to special tax rules.
The Internal Revenue Service is the federal government's tax agency. The IRS manages the levels and flow of all United States income taxes. As of December 2010, all forms of welfare benefits, including non-federal benefits from a state or local agency, are exempt from federal taxation, says the IRS.
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State and Local Taxes
Many state and local governments and agencies administer income taxes, which are in addition to federal income taxes. These governments sometimes require individuals to file separate tax returns. Although income tax procedures vary among state and local governments and agencies, the vast majority of these exempt welfare benefits from taxation.
The federal government has a key exception to the non-taxable welfare benefits rule. According to the IRS, welfare benefits acquired through fraudulent activity are taxable. Additionally, individuals must report income from welfare benefits received as "compensation for services," such as through a job or "workfare" program, on their tax returns.
Social Security and Medicare
Income from basic Medicare programs, including hospital insurance benefits for the elderly and supplemental medical insurance for the aged, is not taxable by the IRS. Additionally, old-age and disability Social Security benefits are also exempt from federal taxation. People on disability insurance who receive compensation for work or services must report income earned from those activities on their yearly tax returns. Work-related compensation for disability-related training or disability accommodation is exempt from taxation.