Which of the following is true regarding tax-exempt income?

Tax-exempt income refers to earnings not subject to federal income tax. Understanding the nuances of inheritances is crucial in this context. Option C highlights that while inheritances themselves are generally not subject to federal income tax, they may be subject to taxation at the state level, depending on the tax laws of the specific state. Some states impose an inheritance tax that could affect the recipient, hence making it essential to acknowledge that state taxes may apply even though the income is exempt federally.

This understanding helps clarify the broader context of tax-exempt income, especially in distinguishing federal regulations from those at the state level. Other options do not accurately reflect these nuances; they either generalize about gifts and inheritances without acknowledging variations in tax obligations or misrepresent the conditions under which these taxes apply.