# Exempt Income: Definition, Examples, and Tax Rules

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> **Definition**
>
> Earnings not subject to income tax, whether federal or state, are referred to as exempt income. 

## What Is Exempt Income?

Exempt income is income that's not subject to [income tax](https://www.investopedia.com/terms/i/incometax.asp). Some types of income are exempt from federal or state income tax, or both. The [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) 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 individual retirement accounts (IRAs) are tax-exempt.
*   Income from certain 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](https://www.investopedia.com/taxes/sources-nontaxable-income/) under certain circumstances. Several health-related benefits are [tax-exempt](https://www.investopedia.com/terms/t/tax_exempt.asp), 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](https://www.investopedia.com/terms/w/workers-compensation.asp).

The [Tax Cuts and Jobs Act (TCJA)](https://www.investopedia.com/taxes/how-gop-tax-bill-affects-you/) in 2017 eliminated personal exemptions from tax years 2018 to 2026 but roughly doubled the [standard deduction](https://www.investopedia.com/terms/s/standarddeduction.asp). For tax years 2024 and 2025, the standard deductions are:

> **Important**
>
> 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)](https://www.investopedia.com/terms/h/hsa.asp) are only exempt from income tax if they are used for qualified medical expenses. Qualified distributions from [Roth 401(k)](https://www.investopedia.com/terms/r/roth401k.asp) plans and [Roth IRAs](https://www.investopedia.com/terms/r/rothira.asp) funded with after-tax dollars are tax-exempt. 

Interest earned from [municipal bonds](https://www.investopedia.com/terms/m/municipalbond.asp) is exempt from federal and state income tax if you reside in the state where the bond was issued.

If someone dies and you are the [beneficiary](https://www.investopedia.com/terms/b/beneficiary.asp) of [a life insurance benefit](https://www.investopedia.com/articles/pf/06/transferlifeinsurance.asp), that is also nontaxable income.

## What Does Exempt Mean?

"Exempt" means "free from." Tax exempt means free from taxes.

## 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](https://www.investopedia.com/terms/o/ordinaryincome.asp) by the federal government, but not all states tax unemployment income. Unemployment compensation is taxed based on the program paying the benefits.

## The Bottom Line

Almost all forms of income are taxable, including wages, [salaries, and tips](https://www.investopedia.com/when-not-to-tip-8736382). But certain forms of income aren't [taxable](https://www.investopedia.com/terms/i/identified-shares.asp). Exempt income includes distributions from Roth retirement accounts, municipal bonds, and certain benefits.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[Traditional and Roth IRAs](https://www.irs.gov/retirement-plans/traditional-and-roth-iras)."
>     
> 2.  Internal Revenue Service. "[Employer-Provided Health Coverage Informational Reporting Requirements: Questions and Answers](https://www.irs.gov/newsroom/employer-provided-health-coverage-informational-reporting-requirements-questions-and-answers)."
>     
> 3.  Internal Revenue Service. "[Publication 525: Taxable and Nontaxable Income](https://www.irs.gov/forms-pubs/about-publication-525)."
>     
> 4.  Tax Policy Center. "[How Did the TCJA Change the Standard Deduction and Itemized Deductions?](https://www.taxpolicycenter.org/briefing-book/how-did-tcja-change-standard-deduction-and-itemized-deductions)"
>     
> 5.  Internal Revenue Service. "[IRS Releases Tax Inflation Adjustments for Tax Year 2025](https://www.irs.gov/newsroom/irs-releases-tax-inflation-adjustments-for-tax-year-2025)."
>     
> 6.  Internal Revenue Service. "[IRS Provides Tax Inflation Adjustments for Tax Year 2024](https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2024#:~:text=For%20single%20taxpayers%20and%20married,amount%20for%20tax%20year%202023.)."
>     
> 7.  Internal Revenue Service. "[Roth Comparison Chart](https://www.irs.gov/retirement-plans/roth-comparison-chart)."
>     
> 8.  Internal Revenue Service. "[Roth IRAs](https://www.irs.gov/retirement-plans/roth-iras)."
>     
> 9.  Internal Revenue Service. "[Publication 969, Health Savings Accounts and Other Tax-Favored Plans](https://www.irs.gov/publications/p969)."
>     
> 10.  Internal Revenue Service. "[Publication 550: Investment Income and Expenses](https://www.irs.gov/forms-pubs/about-publication-550)."
>      
> 11.  Internal Revenue Service. "[Life Insurance & Disability Insurance Proceeds](https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance-disability-insurance-proceeds)."
>      
> 12.  Internal Revenue Service. "[Tax Exempt Bonds](https://www.irs.gov/tax-exempt-bonds)."
>      
> 13.  Internal Revenue Service. "[Unemployment Compensation](https://www.irs.gov/individuals/employees/unemployment-compensation)."