What Is Interest Income for Tax Purposes?
Not all interest income is taxed the same. Learn the tax treatment for various sources and how to properly report these earnings on your annual tax return.
Interest income is the return earned from lending money or the earnings on deposited funds. For tax purposes, the Internal Revenue Service (IRS) views most of this income as taxable. The rules governing how this income is taxed can vary based on its source, which determines whether it is fully taxable, partially taxable, or tax-exempt at the federal or state level.
Common Sources of Taxable Interest Income
Taxable interest is generated from many common sources, including savings accounts, checking accounts, Certificates of Deposit (CDs), and money market accounts. This interest is taxable as ordinary income in the year it is made available to you, even if it is not withdrawn.
Interest from corporate bonds is also a source of taxable income. When you lend money to a company by purchasing its bond, the interest payments are taxable. This also applies when you act as a lender, such as receiving interest on personal loans or from a seller-financed mortgage.
Some payments called “dividends” are treated as interest income for tax purposes. This includes distributions from deposit or share accounts in cooperative banks, credit unions, and mutual savings banks. These payments are taxed at the same rates as your wages or other ordinary income.
Understanding Tax-Exempt and Special Interest
Certain interest income receives special tax treatment. Interest from municipal bonds, which are debt securities issued by states, cities, or other local governments, is exempt from federal income tax. If you purchase municipal bonds issued by your state of residence, the interest is often exempt from state and local income taxes as well.
Interest earned from U.S. Treasury securities, including Treasury Bills, Notes, and Bonds, is subject to federal income tax. This interest is exempt from all state and local income taxes, which distinguishes it from corporate bond interest. This state-level exemption can make Treasury securities a beneficial investment depending on your state tax situation.
U.S. Savings Bonds, specifically Series EE and Series I, have distinct rules. The interest is federally taxable but can be deferred until the bonds are cashed or mature. A tax benefit is available for bondholders who use the proceeds for educational purposes. Interest from Series EE and I bonds issued after 1989 may be excluded from federal income tax if the funds pay for qualified higher education expenses for yourself, a spouse, or a dependent. This benefit is subject to income limitations, and for 2025, it begins to phase out for taxpayers with a modified adjusted gross income (MAGI) between $99,500 and $114,500 for single filers and between $149,250 and $179,250 for those married filing jointly.
Tax Forms for Reporting Interest
The primary document for reporting interest is Form 1099-INT, Interest Income. Financial institutions must send you and the IRS a Form 1099-INT if they paid you $10 or more in interest during the year. You will receive a separate form from each institution that meets this $10 threshold.
Box 1 of Form 1099-INT reports the total amount of taxable interest you received. Box 3 is for interest on U.S. Savings Bonds and Treasury obligations, which is exempt from state and local taxes. Box 8 shows any tax-exempt interest you received, such as from municipal bonds.
A related form is Form 1099-OID, Original Issue Discount, which you may receive if you purchased a bond for less than its face value. The discount is a form of interest that accrues over the bond’s life, and a portion must be reported as income each year, even without a cash payment.
How to Report Interest Income on Your Tax Return
Taxable interest from Form 1099-INT and Form 1099-OID is reported on line 2b of Form 1040. Tax-exempt interest, found in Box 8 of Form 1099-INT, is reported for informational purposes on line 2a of Form 1040.
You must complete and attach Schedule B, Interest and Ordinary Dividends, if your total taxable interest income is more than $1,500. You must also file Schedule B if you had a financial interest in or signature authority over a financial account in a foreign country. Schedule B provides the IRS with an itemized list of each payer and the amount of interest you received.
On Schedule B, you list each source of taxable interest from your 1099 forms in Part I. You then total these amounts and carry the final number to line 2b of your Form 1040. Even if you are not required to file Schedule B, you must still report all taxable interest directly on Form 1040.