What it is:
Tax free means not taxable.
How it works (Example):
For example, many states and municipalities do not charge sales tax on food items. These items are tax free. For many investors, the interest earned from municipal bonds is not subject to federal income taxes. That income is tax free.
Sometimes, states or municipalities have "tax holidays," during which purchases that are normally taxed are tax free. Tax holidays are generally meant to encourage economic activity.
Why it Matters:
Considerable controversy exists regarding what sorts of income, activities, or organizations should be tax free.
It is important to note that even though income may be free from federal income taxes, a taxpayer or organization might still have to pay state, local, or other types of taxes (such as payroll taxes, sales taxes, or excise taxes). Thus, it's hard to find anything that is truly tax free.