Are You Taxed on Savings Account Interest?

Interest earned on money held in a savings account is subject to federal income tax. This income is considered taxable in the year it is credited to your account. This article explains how this interest is treated for tax purposes, how to report it, and situations where it might not be taxable.

How Savings Account Interest Is Taxed

Interest income from a savings account, including interest from checking accounts, money market accounts, and certificates of deposit (CDs), is classified as ordinary income by the Internal Revenue Service (IRS). This means it is taxed at your individual marginal income tax rate, similar to how wages or other earned income are taxed. There is no special lower tax rate for this type of income.

Interest is considered taxable in the tax year it is credited to your account or otherwise made available to you. This applies even if you do not withdraw the interest and instead allow it to compound within the account balance. For example, if interest is credited monthly, each month’s interest becomes taxable in that year, regardless of when you access the funds. This is due to the principle of constructive receipt, meaning you owe tax when you have an unrestricted right to receive income.

Reporting Your Interest Income

Financial institutions, such as banks and credit unions, are required to report interest income paid to their customers to both the account holder and the IRS. They do this by issuing Form 1099-INT, “Interest Income,” which details the total interest paid to you during the calendar year. This form is mailed to you by January 31st of the year following the interest accrual.

You receive a Form 1099-INT if you earned $10 or more in interest from a single financial institution during the tax year. All interest income is taxable, regardless of the amount or whether you receive a Form 1099-INT. If you earn less than $10 in interest, the bank may not issue the form, but you are still legally obligated to report that income on your federal tax return.

This interest income is reported on Schedule B, “Interest and Ordinary Dividends,” which is then used to calculate the total interest income included on your main federal income tax form, Form 1040. Even if you do not itemize deductions, you must still report all taxable interest income.

When Interest May Not Be Taxable

Interest income from a savings account or similar investment may not be subject to federal income tax in specific circumstances. For individuals with very low overall taxable income, the standard deduction may reduce their adjusted gross income to zero. In such cases, interest income earned would not result in an actual tax liability because there is no remaining taxable income after deductions.

Interest earned within certain tax-advantaged retirement accounts also receives special treatment. For instance, interest accumulated within a Roth Individual Retirement Arrangement (IRA) is not taxed when qualified distributions are made in retirement. This is because contributions to a Roth IRA are made with after-tax dollars, and the earnings grow tax-free.

Interest from certain bonds issued by state and local governments, commonly known as municipal bonds, may be exempt from federal income tax. Some municipal bonds may also be exempt from state and local taxes if you reside in the issuing state.