How Much Income From Interest Is Taxable?

Interest income might seem like a simple way to grow your money, but it can come with tax implications that are easy to overlook. Whether you’re earning from savings accounts, bonds or other investments, the IRS often considers that income taxable. Understanding how interest income is taxed, and what exceptions may apply, can help you avoid surprises and keep more of your earnings.

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 accounts 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) plans
• Municipal bonds

One exception are municipal bonds, which are exempt from federal taxes. If they are issued by a state you file taxes in, such as your home state, then they may be exempt there as well. 

Tax-deferred accounts, such as retirement accounts, just delay when you’ll pay tax on the earned interest. With these accounts, you’ll pay tax on withdrawals instead of immediate income.

Tax Rates on Interest Income

On earned income, you will pay tax at the rate of your ordinary income. So if you are in the income tax bracket that requires a 22% tax, for example, then that is the rate 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. In these cases, 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 $1,500 in 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 on 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.

Estimate your total tax bill under different scenarios by using our income tax calculator.

Ways to Cut Taxes on Interest Income

If you’re looking to avoid taxes on the interest income your assets generate, there are some options to consider:

• Placing interest-generating investments into accounts with tax advantages: Accounts like traditional IRAs, Roth IRAs, 401(k)s and HSAs let you either delay taxes until you take the money out or avoid them if you meet the rules for tax-free withdrawals. This means interest from CDs, bonds or money market funds can grow without being taxed each year.
• Investing in municipal bonds: Interest from municipal bonds is typically not taxed at the federal level. Further, if the bond is issued by your state of residence, it may also be free from state taxes. While interest rates on municipal bonds are usually lower than those of taxable bonds, the reduced tax burden can make them more valuable for people in higher tax brackets.
• Shifting from interest-focused investments to those that generate capital gains: Long-term capital gains often have more favorable tax treatment than ordinary income. For instance, replacing a taxable bond fund with a dividend-paying stock fund changes the type of taxable income. However,  this also increases market risk, so it may not be suitable for every investor.
• Planning the timing of when interest income is recognized: If your income will be lower next year, you might delay selling or redeeming certain investments so the interest is taxed in that lower income year. While you can’t always change payment schedules, being aware of when interest is paid can help you better control your tax liability.

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 vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel 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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