Six others militants are also believed to have been killed in the gun battle in Nuristan.
However, the report of Fazlullah's death is yet to be officially confirmed, the sources said.
Clashes between Taliban militants, including those based in Pakistani, and Afghan forces had erupted in Nuristan province three days ago, the sources said.
However, Maulana Faqir Muhammad, the chief of the Pakistani Taliban in Bajaur tribal region, denied that Fazlullah had been killed in a gun battle.
In an interview to BBC in November last year, Fazlullah had said he had escaped to Afghanistan after fleeing a Pakistan army offensive against the Taliban in Swat valley.
Fazlullah and his militants had established a parallel administration that controlled most parts of Swat, a district located just 160 km from Islamabad.
The army wrested control of Swat from the Taliban after a prolonged offensive, though the militants have struck back in recent weeks by carrying out sporadic attacks.