When you earn interest income on your investments or other financial endeavors, then you’ll likely need to pay taxes on all or part of that income. Earned interest is considered the same as any other ordinary income and must be included as part of your federal and state tax returns. The tax rate is the same rate you would pay on any other income that you declare on your tax return. Basically any interest-bearing account will require you to pay tax on the earned income. Any exceptions, which can include municipal bonds, tax earned income as a capital gains tax. If you’re looking for guidance on taxes, you may want to consider working with a financial advisor.
What Is Taxable Interest Income?
Taxable interest income is any money you earn on your investments or savings accounts. When an account pays you interest for the money you have in that account, or you earn an annual percentage yield (APY) on the money you have in the account, then that earned interest is taxable. You will owe taxes on any amount of money that is earned in this manner, potentially even if it’s just $1. All earned interest needs to be reported on your tax returns as income.
Most all earned interest is taxable at both the federal and state levels in the year that it is earned. An exception to this rule would be if you earned interest in a tax-deferred account such as an IRA. You won’t pay tax on those types of accounts until you start taking withdrawals.
What Types of Interest Income Are Taxable?
Earned interest income is almost always taxable if it is earned in an account that isn’t a tax-deferred account, such as a 401(k). Some examples of savings and investment accounts that will require you to pay taxes on the interest you earn from those accounts are:
- U.S. Savings Bonds
- Treasury Bonds
- Corporate bonds
- Certificates of deposit (CD)
- Mutual funds
- Exchange-traded funds (ETFs)
- Loans you make to others
- Money market accounts
- Checking accounts
- Savings accounts
Some examples of accounts that earn interest that is not immediately taxable are:
- Traditional individual retirement accounts (IRA)
- Non-Roth 401(k)s
- Municipal bonds
It should be noted that municipal bonds are exempt from federal taxes and if they are issued by a state you file taxes in, such as your home state, then they may be exempt there as well. The tax-deferred accounts, such as retirement accounts, just delay when you’ll pay tax on the earned interest as you’ll pay tax on withdrawals instead of immediate income.
Tax Rates on Interest Income
There are no specific tax rates for most of the interest that you earn from your savings or investment accounts. Instead, you will pay tax at the rate of your ordinary income. So if you are in the tax bracket that requires a 22% tax then that is what you would pay on your earned interest income. The exception to this is if your income is in a tax-deferred account or if it is exempt from federal tax, such as with municipal bonds, then you don’t have to report the income.
How Interest Income Is Reported on Your Taxes
You should receive a 1099-INT form if you earn interest from a financial institution. This form will have all the information you need to add the income to your tax return. Once you hit the $1,500 of earned interest income for the year you can report all of your taxable interest on Schedule B of your 1040 federal tax return. You still will report interest even if you don’t meet the $1,500 threshold, you would just not file a Schedule B. Each state may require you to input that information in different places of their tax filings.
Keep in mind that while you’re responsible for all earned interest, banks and other financial institutions only have to send you a 1099-INT if you earned more than $10 in interest from your accounts with them throughout the year. This makes it important for you to keep track of all earned interest, especially if you have a lot of savings and investment accounts at different institutions.
Bottom Line
If your current investments include any income-bearing accounts such as mutual funds or CDs, you’ll be required to pay income tax on what you earn, even if you don’t cash the money out of your account. Most of the time you’ll be taxed at your ordinary income tax bracket for the interest you earn. The earned interest will be taxable in the year that it is earned, not the year you receive the money.
Tips for Tax Planning
- If you’re struggling to keep up with your tax planning you may want to enlist the help of a professional. A financial advisor can help you create a financial plan, manage assets and make decisions with taxes in mind. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You can best create a plan if you know about what you’ll end up owing beforehand. Using SmartAsset’s income tax calculator can help you estimate what you may owe in taxes so you can plan ahead and lower your total liability.
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