This paper investigates the economic importance of environmental income to rural households in Nepal and how environmental income influences poverty and inequality measures. Qualitative contextual information was collected from two village development committees in middle Gorkha District followed by a structured survey of 303 randomly selected households; income data were collected quarterly throughout 2008. Average environmental income was 15.7 % of total household income, ranging from 11.0 to 29.5 %. Environmental reliance decreased with rising income while absolute environmental income increased. Ordinary least square regression analysis indicated that households having large areas of crop and other lands, many livestock, larger amount of bank saving and having at least one migrating household member generate significantly larger amount of total household income. Households having a larger household size and the Dalit households generate significantly lower amount of total household income. Poverty indices and Gini decomposition showed that excluding environmental income from total household income has a large negative impact on the proportion of households below poverty lines, the income shortfall as a proportion of poverty lines and the variation in income distribution among households below the poverty lines.