How Savings Accounts Are Taxed

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’ll escape payroll taxes, but you will owe federal income tax on it at your regular rate. Banks and other financial institutions report your interest income on a form 1099-INT if it’s over $10. Consider talking to a financial advisor to understand how savings account interest income may be taxed.

Savings Account Taxes

The money you deposit to a regular savings account has already been taxed and you won’t owe taxes on it when you withdraw it to spend or invest. But interest on savings accounts is considered to be income by the Internal Revenue Service. This is so even if you don’t withdraw the interest from the account.

Interest paid to almost any bank account, including savings, checking, money market accounts and certificates of deposit, is taxable. Dividends on deposits or shared accounts at credit unions, cooperative banks, savings and loans and mutual savings banks are also included as taxable income.

The federal income taxes due on savings account interest are calculated as a percentage of your taxable income according to the current federal income tax brackets. These range from 10% to 37% depending on your income level.

Although you owe income taxes on savings account interest, the income is not considered earned income, such as wages and salary. As unearned income, it is not subject to payroll taxes, including Social Security and Medicare taxes. However, you may also owe state income taxes in addition to the federal levy.

While you will typically be charged a tax for any interest that is earned from your savings account, you won’t have to be taxed on the balance of the money you keep in your account. You should have paid tax on that money prior to putting the money in that account so it isn’t going to be taxed again just for sitting in the account.

How to Report Interest on Your Taxes

A financial institution generally must report $10 or more of reportable interest paid to you for the year on Form 1099-INT. ¹ The form shows interest and certain other information you may need when preparing your federal income tax return.

Sometimes you may not receive a 1099-INT. That doesn’t relieve you of the responsibility for reporting and paying taxes on the interest. This is true even if the interest is less than $10. The $10 threshold generally determines when a payer must issue Form 1099-INT; it is not an exemption that makes smaller amounts of taxable interest tax-free. In that case, you may have to look through your account statements and add up all the taxable interest you’ve received in order to know how much to report on your tax return. Failing to report any interest income could subject you to penalties and interest.

If you don’t provide the bank with your correct taxpayer identification number, you may be subject to backup withholding. ²  When this happens, the bank will withhold 24% of your interest to pay any taxes due. Backup withholding can also apply in certain other circumstances, including when the IRS determines that a taxpayer identification number is incorrect or notifies the payer that required interest or dividend income was underreported.

If your taxable interest for the year exceeds $1,500, you generally report the interest on Schedule B of Form 1040. Schedule B can also be required in other circumstances, so receiving less than $1,500 of interest does not necessarily mean you will never need the schedule.

Accounts That Can Delay or Avoid Taxes on Interest

Some banks offer a special type of savings account, called an IRA savings account, that allows you to deduct from your current income any deposits you make to the account (if you meet IRS eligibility). Interest income on these IRA savings accounts accrues without being taxed, until you withdraw it. Because these accounts typically pay bank savings rates, many investors use their IRAs for investments with more growth potential instead, though some may keep a portion in IRA CDs.

A traditional IRA contribution is not automatically deductible. Whether a contribution can be deducted may depend on income, filing status and whether you or your spouse is covered by a retirement plan at work. Earnings held inside a traditional IRA generally grow tax-deferred.

Withdrawals from a traditional IRA are generally taxable to the extent they consist of deductible contributions and earnings. A distribution before age 59½ can also be subject to a 10% additional federal tax on the taxable portion unless an exception applies.

Some savings accounts for education purposes, such as Coverdell savings accounts and 529 plans, also earn interest tax-free (as long as the money is used to pay for allowable education costs). More precisely, investment earnings in these accounts generally receive favorable federal tax treatment, and qualifying distributions can be federal income tax-free when the applicable requirements for qualified education expenses are satisfied. Tax treatment can differ when distributions are not qualified.

Your last option for getting a tax-exempt savings account is to open a health savings account (HSA). HSA funds can earn interest or be invested, and withdrawals for qualified medical expenses are tax-free. A health savings account balance can be carried over from year to year. To contribute to an HSA, you generally must be covered by a qualifying high deductible health plan and meet the other HSA eligibility requirements.Bottom Line

Savings account interest is taxed as income by the federal government. Interest earnings of more than $10 are reported to the IRS and to you by the bank or other institution where the money is deposited using a 1099-INT form. You are required to report all interest received on your tax return, however, even if it is less than $10 and whether or not you receive a 1099-INT. Interest income is free of payroll taxes, but you’ll pay income taxes on it at your ordinary rate.

Financial Planning Tips

• A financial advisor can help you evaluate your tax situation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• You don’t have to utilize just a single savings account. In fact, you can use a number of accounts to help you with different things. For example, you may want to keep your emergency fund in a high-yield savings account but you may also want to open an HSA while keeping retirement savings in an IRA account. All of this can 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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