12 Top Sources of Nontaxable Income

Not all of your income is subject to federal or state taxes

Most of the income you earn through work or investments is subject to federal income tax and sometimes state income tax, as well. But certain categories of income are exempt from income tax. Here are 12 that every taxpayer should know about.

Key Takeaways

  • Most of your income is probably taxable, but federal and state tax laws provide some exceptions.
  • States differ in how they tax income, and some have no income tax at all.
  • Certain investments can provide tax-free income, including interest on municipal bonds and the income realized on contributions to Roth retirement accounts.

1. Disability Insurance Payments

Disability benefits are taxable if your employer paid the premiums for the policy; however, there are some categories of disability benefits that are nontaxable:

  • Any benefits you receive from supplemental disability insurance you purchased through your employer with your own after-tax dollars.
  • Any benefits you receive from a private disability insurance plan you purchased with after-tax dollars.
  • Workers' compensation payments.
  • Compensatory (but not punitive) damages for physical injury or physical sickness, compensation for the permanent loss or loss of use of a part or function of your body, or compensation for permanent disfigurement.
  • Disability benefits from a public welfare fund.
  • Disability benefits under a no-fault car insurance policy for loss of income or earning capacity as a result of injuries.

2. Employer-Provided Insurance

The IRS says that "in most cases, the value of accident or health plan coverage provided to you by your employer is not included in your income." This could be health insurance provided by your employer through a third party (like Aetna or Blue Cross) or coverage and reimbursement for medical care provided through a health reimbursement arrangement (HRA). Employer-provided long-term care insurance is also not taxable.

In addition, an employee does not pay tax on the cost of up to $50,000 of group term life insurance provided by an employer. In other words, if your employer pays $250 to give you a life insurance policy with a $50,000 death benefit, you don't owe any tax on that $250.

However, if your employer pays the cost of more than $50,000 of group term life insurance, you'll pay tax on the cost of the excess coverage. So if your employer pays $283 to give you $80,000 of insurance coverage, you'll owe tax on $33.

3. Health Savings Accounts (HSAs)

Distributions from a health savings account (HSA) are not taxable, as long as you use them for qualified medical expenses. You can only contribute to an HSA when you're enrolled in a high-deductible health insurance plan; however, you can take distributions at any time. And if your employer contributes to your HSA, that money is usually tax-free, too.


If you're disabled, or if you're 65 or older, HSA distributions aren't taxable—even if you don't use the money for qualified medical expenses. (L21)

4. Life Insurance Payouts

If a loved one dies and leaves you a life insurance benefit, this income is generally not taxable, with some exceptions. Also, if you cash in or convert a life insurance policy you own, there may be tax implications.

If you receive accelerated benefits from your life insurance plan because you're terminally ill, these payments usually aren't taxable. If you receive this money as periodic payments because you're chronically ill, it may not be taxable if you use the money for long-term care.

5. Earned Income in 8 States

States vary in the kinds of income they tax and the rates at which they tax it. Eight states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming—have no individual income tax at all. New Hampshire taxes only interest and dividend income, not earned income from salary and wages. Most states don't tax Social Security income, but the federal government does.

6. Corporate Income Earned in 6 States

There are no corporate income taxes in six states—Nevada, Ohio, Texas, Washington, South Dakota, and Wyoming—according to the Tax Foundation; however, Nevada, Ohio, Texas, and Washington do tax a corporation's gross receipts. Two states—South Dakota and Wyoming—tax neither.

7. Sale of a Principal Residence

Individuals and married couples who meet the IRS's ownership and use tests, meaning that they have owned their home for at least five years and have lived in it as a principal residence for at least two of the last five years, can exclude from their income up to $250,000 (for individuals) or $500,000 (for married couples filing jointly) of capital gains when they sell the home.

8. Financial Gifts

If you receive money or other property without providing something of equal value in return, it's considered a gift, and you won't have to pay income tax on it. The giver usually won't have to either, because the lifetime gift tax exemption is $12.06 million for 2022 and $12.92 million for 2023. If the gift later produces income (say, your gift was $12,000 worth of stock), you will have to pay tax on that income.

9. Inheritances

Inheritances are not considered taxable income; however, estates over a certain size may be subject to estate taxes, which are paid by the estate itself. For 2022, the federal estate tax exemption is $12.06 million. For 2023, it is $12.92 million. Any amount over the exemption is subject to tax.

10. Municipal Bond Interest

Most of the time, when you invest in bonds, you have to pay federal and state taxes on the income you receive from them. One exception is municipal bonds, issued by states and other government entities. Their income is generally tax-free on the federal level and also at the state and local level if you live in the state where the bonds were issued.

This tax exemption applies whether you invest in individual municipal bonds or buy them through a municipal bond fund or ETF. Interest income from U.S. Treasury bills, notes, and bonds is subject to federal income tax but exempt from state and local income taxes.


Municipal bonds often pay less than other types of bonds. But, depending on your tax bracket, they may offer a better after-tax return than their taxable counterparts.

11. Up to $3,000 of Income Offset by Capital Losses

If you sell investments at a loss, you can use your loss to reduce your taxable income by up to $3,000 a year. What's more, capital losses can be carried over from year to year until you offset your entire loss. For example, if you sold investments at a loss of $4,500 in 2022, you could subtract $3,000 from your taxable income on your 2022 tax return and the remaining $1,500 from your income on your 2023 tax return.

12. Roth Retirement Account Income

Qualified retirement accounts, such as 401(k) plans, 403(b) plans, and IRAs, offer a number of tax advantages, including deferring any tax on your investment income and gains until you withdraw the money. In the case of Roth 401(k)s, Roth 403(b)s, and Roth IRAs, the money you withdraw is not taxable at all as long as you meet the rules on Roths.

Which States Don't Tax Income?

The income you earn as an individual in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming isn't subject to state income tax.

What Types of Gifts Are Never Taxable?

  • Tuition or medical expenses paid on someone else's behalf
  • Political donations
  • Gifts to charities. Unlike other types of gifts, charitable donations are also tax-deductible.

If I Give My Employee a Gift, Is It Taxable?

Financial gifts from employers, such as cash or gift cards, are usually considered fringe benefits, not gifts, and are treated as taxable income; however, an infrequent gift of modest value, such as a holiday fruitcake, is considered a de minimis benefit and not taxed.

Where Can I Get More Information on Income That's Not Taxed?

The IRS provides detailed information on taxable and nontaxable income in its annually updated Publication 525.

The Bottom Line

The IRS's default position is that all income is taxable unless it says otherwise; however, that doesn't mean you should assume all your income is up for grabs: the tax code contains dozens of exceptions to that rule. Planning to legally take advantage of those exceptions could help you live a richer life.

Article Sources
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  1. Internal Revenue Service. "Life Insurance & Disability Insurance Proceeds."

  2. Internal Revenue Service. "Publication 907: Tax Highlights for Persons with Disabilities," Pages 3-4.

  3. Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Page 5.

  4. Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Pages 6-7.

  5. Internal Revenue Service. "Publication 969: Health Savings Accounts and Other Tax-Favored Health Plans," Page 5.

  6. Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Page 6.

  7. Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Page 23.

  8. Tax Foundation. "State Individual Income Tax Rates and Brackets for 2022."

  9. Tax Foundation. "State Corporate Income Tax Rates and Brackets for 2022."

  10. Internal Revenue Service. "Publication 523, Selling Your Home," Pages 2-4.

  11. Internal Revenue Service. "What's New - Estate and Gift Tax."

  12. Internal Revenue Service. "Publication 559," Page 13.

  13. Internal Revenue Service. "Publication 525, Taxable and Nontaxable Income," Page 6.

  14. Internal Revenue Service. "Publication 4079, Tax-Exempt Governmental Bonds," Page 2.

  15. Internal Revenue Service. "Topic No. 409, Capital Gains and Losses."

  16. Internal Revenue Service. "IRC 403(b) Tax-Sheltered Annuity Plans."

  17. Internal Revenue Service. "401(k) Plans."

  18. Internal Revenue Service. "Individual Retirement Arrangements - Getting Started."

  19. Internal Revenue Service. "Roth Account in Your Retirement Plan."

  20. Internal Revenue Service. "Frequently Asked Questions on Gift Taxes."

  21. Internal Revenue Service. "De Minimis Fringe Benefits."

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