Do You Have to Pay Tax on Bank Interest?

General Taxability of Bank Interest

Bank interest represents money earned on funds held in various deposit accounts, such as savings accounts, checking accounts, money market accounts, and certificates of deposit (CDs). This income accrues to account holders as compensation for lending their money to financial institutions. In most cases, the interest received from these accounts is subject to taxation by federal, and often state and local, governments.

The Internal Revenue Service (IRS) generally considers bank interest as ordinary income. This classification means it is taxed at the taxpayer’s regular income tax rates, similar to wages or salaries. The obligation to pay tax on this income applies whether the interest earned is withdrawn by the account holder or automatically reinvested back into the account.

There is no minimum amount of interest that is exempt from taxation. Even small amounts, perhaps a few cents, are technically considered taxable income. This principle underscores that all interest earned, regardless of its size, contributes to an individual’s total taxable income for the year. Therefore, understanding these tax implications is important for anyone earning interest.

Receiving and Reporting Interest Income

Financial institutions play a role in notifying account holders about the interest they have earned. Banks and other entities are generally required to issue Form 1099-INT, “Interest Income,” to individuals who have earned $10 or more in interest from a single source during a calendar year. This form details the total interest income, any tax-exempt interest, penalties for early withdrawals, and potentially foreign tax paid on interest.

Even if an individual earns less than $10 in interest from a particular bank and does not receive a Form 1099-INT, the income remains taxable. Taxpayers are responsible for accurately reporting all interest income, regardless of whether they receive this specific form. Maintaining personal records of all interest earned, even small amounts, can assist in fulfilling this reporting obligation.

Reporting interest income on a federal tax return involves specific steps. For most taxpayers, taxable interest income is entered on Line 2b of Form 1040, “U.S. Individual Income Tax Return.” If the total taxable interest income exceeds $1,500, or if certain other conditions apply, taxpayers must also file Schedule B, “Interest and Ordinary Dividends.” Schedule B provides a detailed list of the sources and amounts of interest income, with the total then transferred to Form 1040.

Common Scenarios for Bank Interest

Interest earned on jointly held accounts typically appears under the Social Security number of the primary account holder listed with the financial institution. However, for tax purposes, each joint owner is responsible for reporting their share of the income. The division of this income for reporting should reflect the actual ownership and contributions to the account, often split equally among the joint owners.

Interest income generated in accounts held for minor children may be subject to specific tax rules. If a child’s unearned income, which includes bank interest, exceeds certain thresholds ($1,300 for 2023 and $1,250 for 2024), it might be taxed at the parents’ marginal tax rates under what is commonly known as the “kiddie tax” rules. Otherwise, if the amounts are below these thresholds, the interest is reported on the child’s own tax return.

Interest from U.S. savings bonds offers different tax treatment compared to traditional bank interest. While interest earned on these bonds is generally subject to federal income tax, it is exempt from state and local income taxes. Furthermore, federal tax on U.S. savings bond interest can be deferred until the bond is redeemed or matures, or potentially be entirely tax-exempt if the proceeds are used to pay for qualified higher education expenses.