You are required to report and pay federal taxes on any interest income you receive from a savings account. The income is taxed as unearned, which means you will escape payroll taxes, but you will owe federal income tax at your normal rate. Banks and other financial institutions report your interest income on a Form 1099-INT if it exceeds $10.
Consider talking to a financial advisor to understand how interest income from savings accounts may be taxed.
Taxes on savings accounts
The money you deposit in a regular savings account has already been taxed and you won’t have to pay tax when you withdraw it to spend or invest it. But interest on savings accounts is considered income by the Internal Revenue Service. This is so even if you do not withdraw the interest from the account.
Interest paid on almost all bank accounts, including savings accounts, checking accounts, money market accounts and certificates of deposit, is taxable. Dividends on deposits or shared accounts in credit unions, cooperative banks, savings and credit unions, and mutual savings banks are also included in taxable income.
Federal income tax due on savings account interest is calculated as a percentage of your taxable income according to the applicable federal tax brackets. These range from 10% to 37% depending on your income level.
Although you owe income tax on savings account interest, the income is not considered earned income, such as wages and salaries. As capital income, it is not subject to social charges, including social security and health insurance contributions. However, you may also owe state income taxes in addition to the federal levy.
Although you generally have to pay tax on the interest earned on your savings account, you won’t have to pay tax on the balance of money you keep in your account. You should have paid tax on that money before depositing it into that account so it wouldn’t be taxed again just because it stayed in the account.
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How to file your taxes on interest earned
The financial institution that holds your savings account is required to report to the IRS any interest payments totaling more than $10 for the year, using Form 1099-INT. The bank or other payer is required to send you a copy of the form before the end of January. You may receive it by mail or it may be available as a document accessible through your online account. The amounts on this form are required to properly file your tax returns.
Sometimes you may not receive 1099-INT. However, this does not absolve you of the responsibility of reporting and paying taxes on interest. This is true even if the interest is less than $10. If it is less than $10, the bank will not send a form. In this case, you may need to look at your account statements and add up all the interest you received so you know how much to report on your tax return. Failure to report interest income could expose you to penalties and interest.
If the bank did not send you a 1099-INT because you did not provide a social security number when opening the account, you may be subject to withholding tax. When this happens, the bank will withhold 24% of your interest to pay the taxes owed. You may also be subject to withholding tax if you provided an engaged social security number or if you previously failed to file a return.
Savings accounts that do not charge interest
Some banks offer a special type of savings account, called an IRA savings account, which allows you to deduct any deposits you make into the account from your current income. The interest income on these IRA savings accounts accumulates tax-free, as long as you don’t withdraw it.
However, once you withdraw money, including interest from the IRA savings, it becomes taxable as income. Also, if you withdraw from an IRA savings account before age 59.5, you must pay an additional fee.
Some education savings accounts, such as Coverdell savings accounts and 529 plans, also earn tax-free interest. You won’t pay tax on the interest on these accounts as long as the money is used for education. You can’t use the money in these accounts for non-educational purposes, which might make it difficult for some if you’re looking to withdraw money from your savings for other reasons.
Your final option for getting a tax-exempt savings account is to open a Health Savings Account (HSA) or Flexible Spending Account (FSA). Both are used to pay for health care expenses, but have slightly different rules. A health savings account balance can be carried over from year to year, but you must have a high-deductible health plan to open one. An FSA, on the other hand, has a balance that must be used by the end of the year.
Conclusion
Interest from savings accounts is taxed as income by the federal government. Interest income over $10 is reported to the IRS and to you by the bank or other institution where the money is deposited using a Form 1099-INT. You are required to report all interest received on your tax return, even if it is less than $10 and whether or not you receive a 1099-INT. Interest income is exempt from payroll taxes, but you will pay tax on this income at your ordinary rate.
Saving tips
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A financial advisor can help you assess your tax situation. SmartAsset’s free tool The free tool connects you with up to three financial advisors who serve your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you reach your financial goalsstart now.
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You don’t have to use just one savings account. In fact, you can use a number of accounts to help you with different things. For example, you might want to keep your emergency fund in a high-yield savings account, but you might also want to open an HSA while keeping your retirement savings in an IRA account. This can all get complicated pretty quickly, so you can use a savings calculator to help you figure out how much should be in each account.
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