How is interest income taxed?
For the most part, interest income is taxed as ordinary income, which means it is taxed in the same manner as income from a job. Depending on your income, tax deductions, and other variables, the income tax brackets (marginal tax rates) currently range from 10% to 37%.
Interest is reported to the IRS on Form 1099-INT, which is issued by the institution (such as your bank) that pays you interest. Box 1 of this form will have all of the interest income you were paid during the year. When you fill out your tax return each year, interest income is reported in Schedule B: Interest and Ordinary Dividends. But it's worth noting that if you use tax preparation software to complete your return, the information you enter will automatically be placed on the correct form.
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How much interest income can I earn on my savings tax-free?
Technically, the IRS requires you to report (and pay tax on) all of your interest income. Having said that, there are a couple of things to know.
First, the institution that pays you interest (your bank) is only required to send you a Form 1099-INT documenting the income if they paid $10 or more during the tax year. A copy of this form will also be sent to the IRS. So, if your bank account paid you $2 in interest last year, there won't be any tax documentation on it. To be sure, we're not telling you not to report your savings interest, but $10 is the threshold where your bank is required to report it.
According to the IRS, "You must report all taxable and tax-exempt interest on your federal income tax return, even if you don't receive a Form 1099-INT or Form 1099-OID." If you don't receive a Form 1099-INT for your savings account, you can use your statements to figure out how much interest you received. So, just to be perfectly clear, if you earned just a few cents of interest from your savings account, you're still legally required to report it.
It's also worth pointing out that if you don't have any taxable income, your savings interest may not be taxable. For example, if your savings interest plus all of your other income is less than your applicable tax deductions, you likely won't have to pay any tax on it.
The other caveat is that you don't have to pay tax on interest you earn on a retirement account. For example, if you have $20,000 in cash in your traditional IRA and your broker pays you $50 in interest on that money this year, it won't be taxable until you withdraw the money from the account. It's fairly common to open CDs or other interest-bearing deposit accounts within retirement accounts, and these can be a good way to earn savings interest without having to pay tax.
Will you have to pay tax on your savings interest?
If you receive more than $10 in savings interest from your bank, the answer is yes, unless the interest was paid within a retirement account, or you don't have any federal income tax liability at all. Not only will you be issued a tax document for the interest, but a copy will be sent to the IRS as well. In other words, the IRS will know how much interest you've been paid.
If you receive less than $10, you are still required to report the interest you receive and pay any applicable tax on it. However, it's completely on you to report it at that point, as there will be no tax documentation issued by your bank.
LEARN MORE: How to Calculate Interest Rate on Savings Accounts
