Exempt Income: Definition, Examples, and Tax Rules

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Lea Uradu, J.D. is a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, and Tax Writer.

Suzanne is a content marketer, writer, and fact-checker. She holds a Bachelor of Science in Finance degree from Bridgewater State University and helps develop content strategies for financial brands.

What Is Exempt Income?

Exempt income refers to certain types of income not subject to income tax. Some types of income are exempt from federal or state income tax or both. The IRS determines which types of income are exempt from federal income tax and the circumstances for each exemption. States have their own rules that define what counts as exempt income.

Key Takeaways

• Exempt income is not subject to taxation.
• Some income may be exempt at the state level but taxed at the federal level.
• Income from some types of investments, like municipal bonds, qualifies as exempt income.
• Distributions from Roth 401(k)s and Roth IRAs are tax-exempt.
• Income from benefits, such as employer-sponsored supplemental disability insurance and most benefits from employer-sponsored health insurance plans, are exempt from taxes.

Understanding Exempt Income

Some income and benefits are nontaxable under certain circumstances. Several health-related benefits are tax-exempt, including benefits from employer-sponsored supplemental disability insurance purchased with after-tax dollars, private insurance plans funded with after-tax dollars, most benefits from employer-sponsored health insurance plans, and worker's compensation.

Gifts that exceed a certain value can trigger a gift tax on the person providing the gift. However, any gift worth less than $17,000 in 2023 and $18,000 in 2024 is exempt from income tax. Regardless of value, gifts, including medical expenses paid for someone else and charitable donations, are income tax exempt. Charitable contributions are also tax-deductible.

The Tax Cuts and Jobs Act (TCJA) in 2017 eliminated personal exemptions from tax years 2018 to 2026 but roughly doubled the standard deduction. For tax years 2023 and 2024, the standard deductions are:

When you file your taxes, you can choose between taking the standard deduction or itemizing your deductions. Examples of itemized deductions include medical expenses, mortgage interest, and charitable donations.

Examples of Exempt Income

Distributions from health savings accounts (HSAs) are only exempt from income tax if they are used for qualified medical expenses. Qualified distributions from Roth 401(k) plans and Roth IRAs funded with after-tax dollars are tax-exempt.

Other investments may also be protected from income tax. For example, interest earned from municipal bonds is exempt from federal and state income tax if you reside in the state where the bond was issued. Capital losses from sold investments can also reduce your taxable income by up to $3,000 annually.

If someone dies and you are the beneficiary of a life insurance benefit, that is also nontaxable income but may be subject to estate tax. The estate tax, or death tax, applies to a portion of an estate after it exceeds a certain threshold, $12.92 million in 2023 and $13.61 million in 2024.

The alternative minimum tax (AMT) exemptions are in effect until 2025. The 2023 exemption amount was $81,300 with a phase-out of $578,150 for individuals and $126,500 for married couples filing jointly with a phase-out of $1,156,300. For tax year 2024, the exemption is $85,700 for single filers and begins to phase out at $609,350. For married couples in 2024, it's $133,300 for married couples filing jointly, with phase-out at $1,218,700.

What Types of Income Are Tax Exempt?

Income from municipal bonds and distributions from Roth 401(k)s and Roth IRAs are tax-exempt. Income from employer-sponsored benefits—including supplemental disability insurance and most benefits from employer-sponsored health insurance plans—are exempt.

Is Unemployment Income Taxed?

Unemployment benefits are treated as ordinary income by the federal government, but not all states tax unemployment income. Unemployment compensation is taxed based on the program paying the benefits.

How Much Is the Gift Tax?

In 2023, gifts worth less than $17,000 are not subject to income tax. This value increases to $18,000 in 2024.

The Bottom Line

Almost all forms of income are taxable including wages, salaries, tips, and other types of income from an employer or as a freelancer. But certain forms of income aren't taxable. Exempt income includes things like distributions from some retirement accounts, gifts under a certain amount, certain benefits, and private insurance plans.

1. Internal Revenue Service. "Traditional and Roth IRAs."
2. Internal Revenue Service. "Employer-Provided Health Coverage Informational Reporting Requirements: Questions and Answers."
3. Internal Revenue Service. "Publication 525: Taxable and Nontaxable Income."
4. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2024."
5. Internal Revenue Service. "Frequently Asked Questions on Gift Taxes."
6. Tax Policy Center. "How Did the TCJA Change the Standard Deduction and Itemized Deductions?"
7. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."
8. Internal Revenue Service. "Roth Comparison Chart."
9. Internal Revenue Service. "Roth IRAs."
10. Internal Revenue Service. "Publication 969, Health Savings Accounts and Other Tax-Favored Plans."
11. Internal Revenue Service. "Topic No. 409 Capital Gains and Losses."
12. Internal Revenue Service. "Publication 550: Investment Income and Expenses."
13. Internal Revenue Service. "Estate Tax."
14. Internal Revenue Service. "Life Insurance & Disability Insurance Proceeds."
15. Tax Policy Center. "How Did the TCJA Change the AMT?"
16. Internal Revenue Service. "Tax Exempt Bonds."
17. Internal Revenue Service. "Unemployment Compensation."

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A widow(er)'s exemption is one of several forms of state or federal tax relief available to a surviving spouse in the period following their spouse's death.

A filing extension is an exemption made for taxpayers who are unable to file their federal tax return by the regular due date.

A flow-through entity is a legal business entity that passes income to the owners and/or investors of the business. It's sometimes referred to as a disregarded entity.

A qualified higher education expense is a tax credit for the parents of students attending a college or other post-secondary institution.

Pretax earnings is a company's income after all operating expenses have been deducted from total sales, but before income taxes have been subtracted.

Earned income includes wages, salaries, bonuses, commissions, tips, and net earnings from self-employment. On your taxes, it is treated differently than unearned income.

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