What Income Is Not Subject to Income Taxation?

Federal tax law treats most money you receive as taxable, but a specific list of receipts is excluded from gross income by statute. Income that is not taxable includes gifts and inheritances, life insurance death benefits, compensatory damages for physical injury, qualified scholarships, a limited amount of gain on the sale of your home, interest on state and local bonds, employer-paid health insurance, traditional 401(k) contributions, qualified Roth IRA distributions, child support, needs-based public assistance, and veterans’ benefits. Each category has its own rules and limits, and a few common types of income that look tax-free actually are not.

Gifts and Inheritances

Money or property you receive as a gift, bequest, or inheritance is not part of your gross income.¹²³

The exclusion covers the transfer itself. Income the asset produces after it belongs to you, such as rent from an inherited house or dividends from inherited stock, is taxable like any other income.¹

Stepped-Up Basis on Inherited Property

When you later sell something you inherited, your tax basis is generally the fair market value on the date the previous owner died, not what they originally paid.⁴ If a parent bought stock for $20,000 and it was worth $100,000 the day they died, your basis is $100,000. Sell it for $105,000 and only $5,000 is taxable gain.

Large Foreign Gifts Must Be Reported

A gift or inheritance from a foreign person or estate worth more than $100,000 in a single year must be reported on Form 3520, even though the money is not taxable.⁵ Missing the deadline triggers a penalty of 5 percent of the gift’s value for each month it goes unreported, up to 25 percent.⁶

Life Insurance Death Benefits

A life insurance payout received because the insured person died is excluded from gross income.⁷ A $250,000 lump sum comes to the beneficiary entirely tax-free.

Installment payouts work a little differently. The principal portion of each check is still tax-free, but the interest the insurer pays on the balance it is holding for you is taxable in the year you receive it.⁷

Employer Group-Term Coverage

Employer-provided group life insurance is tax-free up to $50,000 of coverage. The calculated cost of coverage above that amount is a taxable fringe benefit and shows up on your W-2.⁸ The eventual death benefit to your beneficiary remains excluded from their income regardless of the coverage amount.

Personal Injury Settlements

Compensatory damages received for a physical injury or physical illness are excluded from gross income, whether from a verdict or a settlement.⁹ The exclusion reaches medical expenses, pain and suffering, and lost wages tied to the physical harm.

Two categories fall outside the exclusion:

Punitive damages are taxable in nearly all cases, even when the underlying claim was for physical injury.⁹
Damages for emotional distress that did not originate from a physical injury or illness are taxable, except for amounts that reimburse you for actual medical care you paid to treat the distress and did not previously deduct.¹⁰

Mixed settlements need a clear allocation between the taxable and excluded portions, and the IRS may examine how that breakdown was reached.

Qualified Scholarships and Fellowships

If you are a degree candidate, scholarship or fellowship money spent on tuition, required fees, books, supplies, and equipment is excluded from your gross income.¹¹ The item has to be required for enrollment or for the course. Amounts you spend on room and board, travel, or optional supplies are taxable.

Any scholarship money that is really pay for teaching, research, or other services is taxable, even when performing those duties is a condition of the award.¹² Narrow exceptions apply to certain federal programs, including the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship Program.

Gain on the Sale of Your Home

When you sell your main home at a profit, you can exclude up to $250,000 of gain as a single filer, or up to $500,000 on a joint return.¹³ To qualify, you must have owned and used the home as your primary residence for at least two of the five years before the sale. Those two years do not have to be consecutive, and they can add up to any 730 days within the five-year window.

The exclusion is available only once every two years.¹³ A surviving spouse who sells within two years of the other spouse’s death can still claim the full $500,000 on a single return, provided the couple met the ownership and use tests immediately before the death. Gain above the applicable limit is taxed as a capital gain.

Interest on State and Local Bonds

Interest on bonds issued by states, cities, counties, and other local government entities is excluded from federal gross income.¹⁴ The federal exclusion does not extend automatically to state income tax. Most states tax interest from other states’ bonds while exempting their own, so check the rules of the state where you file before assuming the interest is fully tax-free.

Employer Health Coverage and 401(k) Contributions

Two of the largest exclusions many workers ever receive show up quietly on the paycheck.

Employer-Paid Health Premiums

Premiums your employer pays toward your health coverage are not part of your gross income.¹⁵ The portion you pay by payroll deduction under a cafeteria plan is generally excluded as well. Together these amounts can easily reach thousands of dollars a year that never appear on your W-2 as wages.

Traditional 401(k) Elective Deferrals

Contributions you make to a traditional 401(k) by payroll deduction are excluded from your gross income for the year.¹⁶ For 2026, the elective deferral limit is $24,500. Workers age 50 and older can add an $8,000 catch-up, and workers age 60 through 63 can add up to $11,250 under the SECURE 2.0 Act.¹⁷ The exclusion is a deferral, not forgiveness: withdrawals in retirement are taxed as ordinary income.

Qualified Roth IRA Distributions

Qualified distributions from a Roth IRA are entirely excluded from gross income.¹⁸ Roth contributions are made with money that has already been taxed, so both the growth and the eventual withdrawals come out tax-free once the account qualifies.

A distribution is qualified only when both conditions are met:

Five tax years have passed since your first contribution to any Roth IRA.
You are age 59½ or older, you are disabled, or the distribution is paid to a beneficiary after your death.¹⁸

Withdrawals that miss either test may be partially taxable, and the earnings portion can also trigger a 10 percent early-withdrawal penalty.

Child Support

Child support you receive is not taxable income, and the person paying it cannot deduct the payments.¹⁹ You leave it out of your gross income and out of any calculation that decides whether you have to file. This rule applies regardless of when the divorce or separation agreement was executed.

Public Assistance and Veterans’ Benefits

Needs-based government payments, including welfare and Supplemental Security Income (SSI), are not subject to income tax.²⁰ SSI is a separate program from regular Social Security retirement and disability, which follow different rules.

Benefits paid by the Department of Veterans Affairs are also excluded. That covers VA disability compensation, VA pension, GI Bill education assistance, and grants for home or vehicle modifications tied to service-connected disabilities.²¹ A veteran receiving $1,500 a month in VA disability compensation owes no federal income tax on any of it.

Social Security Benefits Are a Different Story

Regular Social Security retirement, survivor, and disability benefits are not the same as SSI. They can be partly taxable depending on your other income. The IRS looks at your “combined income,” which is your adjusted gross income plus any nontaxable interest plus half of your Social Security benefits, and compares it to two thresholds.²²

Combined income under $25,000 (single) or $32,000 (married filing jointly): none of your benefits are taxable.
Combined income of $25,000 to $34,000 (single) or $32,000 to $44,000 (joint): up to 50 percent of your benefits may be taxable.
Combined income above $34,000 (single) or $44,000 (joint): up to 85 percent of your benefits may be taxable.²²

Married taxpayers who file separately and live together at any point during the year have a base amount of zero, so up to 85 percent of their benefits is always taxable. Retirees with pension income, investment earnings, or part-time wages often cross a threshold without realizing it.

1
Office of the Law Revision Counsel. 26 USC 102 – Gifts and Inheritances
2
Internal Revenue Service. Estate Tax
3
Internal Revenue Service. Whats New – Estate and Gift Tax
4
Internal Revenue Service. Gifts and Inheritances
5
Internal Revenue Service. Instructions for Form 3520
6
Internal Revenue Service. Gifts From Foreign Person
7
Office of the Law Revision Counsel. 26 USC 101 – Certain Death Benefits
8
Internal Revenue Service. Group-Term Life Insurance
9
Office of the Law Revision Counsel. 26 USC 104 – Compensation for Injuries or Sickness
10
Internal Revenue Service. Tax Implications of Settlements and Judgments
11
Office of the Law Revision Counsel. 26 USC 117 – Qualified Scholarships
12
Internal Revenue Service. Publication 970, Tax Benefits for Education
13
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
14
Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds
15
Office of the Law Revision Counsel. 26 USC 106 – Contributions by Employer to Accident and Health Plans
16
Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
17
Internal Revenue Service. Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits
18
Office of the Law Revision Counsel. 26 USC 408A – Roth IRAs
19
Internal Revenue Service. Alimony, Child Support, Court Awards, Damages
20
Internal Revenue Service. Social Security Income
21
Internal Revenue Service. Veterans Tax Information and Services
22
Office of the Law Revision Counsel. 26 USC 86 – Social Security and Tier 1 Railroad Retirement Benefits