Tax on savings accounts: How tax on interest income works
Key takeaways
Interest earned on savings accounts is typically considered taxable income at the federal level — and may also be taxed by your state — regardless of whether you withdraw it or leave it in the account.
If you earn interest above the reporting threshold, your bank will usually issue a Form 1099-INT, and you’re required to include that income when filing your tax return.
Understanding how interest income is taxed can help you better evaluate after-tax returns and compare savings options, especially when choosing between taxable accounts and tax-advantaged alternatives.
Whether you're stashing away funds in a high-yield savings account, a money market deposit account, or investing in certificates of deposit (CDs), understanding how your savings income is taxed could significantly impact your financial strategy.
This guide is designed to help you understand how interest income is taxed, explore tax rates and strategies to minimize taxes, and provide insights to help you navigate the tax landscape effectively.
Understanding the basics of savings tax income
First, let's take a look at the basic tax implications of interest income, including its tax rate, how it’s taxed, and when you should declare income on interest you’ve earned.
What is the tax rate on interest income?
Interest income earned from savings accounts, money market deposit accounts, and CDs is typically subject to federal income tax. Your interest income tax rate varies based on several factors, including your overall income level and filing status. Generally, interest income is taxed at your ordinary income tax rate, which ranges from 10% to 37% as of 2023. However, interest income may also be subject to additional taxes, such as the Net Investment Income Tax (NIIT) for higher-income earners or state income tax.
How is interest income taxed?
Interest income is typically taxed at your ordinary income tax rate, which means the rate you pay depends on your total taxable income for the year. This income includes earnings from savings accounts, CDs, bonds, and other investments.
Does interest income count as earned income?
Interest income is categorized as unearned income rather than earned income. Earned income includes wages, salaries, tips, and self-employment income, which are subject to different tax rules than unearned income, such as interest, dividends, and capital gains.
Do I need to report interest income less than $10?
While there may be a threshold for reporting certain types of income to the IRS, it's important to note that all interest income, regardless of the amount, should technically be reported on your tax return. Even if you earned less than $10 in interest income from a savings account or other sources, it's advisable to report it accurately to ensure compliance with tax laws.
Taxation of different saving vehicles
You may be wondering if you must pay taxes on high-yield savings accounts, money market deposit accounts, and CDs. Simply put: yes, interest earned on these accounts is taxable. Below is an overview of each type of account and how they're taxed.
Is savings account interest taxable?
Yes, there is a savings account tax. Interest income from savings accounts is considered taxable income by the IRS. Here's a breakdown of how savings account interest is taxed:
- Taxable income: Interest earned on savings accounts is categorized as taxable income, similar to other forms of interest income, such as the interest earned on CDs.
- Ordinary income tax rate: The interest earned on savings accounts is subject to taxation at your ordinary income tax rate, which is determined by your total taxable income for the year. Your ordinary income tax rate may vary depending on your income level and filing status (e.g., single, married, filing jointly, etc.).
- Reporting requirements: Financial institutions that hold your savings account typically provide investors with Form 1099-INT at the end of the tax year. This form reports the total amount of interest income earned on the savings account during the year. Taxpayers must report this interest income on their federal income tax return (Form 1040 or 1040-SR) under the "Interest Income" section. Raisin customers receive consolidated tax documentation when they have earned $10 or more in interest via Raisin.
- Withholding: Some financial institutions may withhold taxes on savings account interest payments, depending on the investor's tax status and the amount of interest earned. If taxes are not withheld, such as the case with products held in your Raisin account, savings account interest is still considered taxable income and must be reported on the taxpayer's tax return.
- Penalty fees: If you withdraw funds from a savings account before its maturity date or exceed the allowed number of withdrawals per statement cycle, you may incur penalty fees imposed by the financial institution. These penalty fees are not tax-deductible and are considered separate from the savings account interest income taxation.
How are high-yield savings accounts taxed?
High-yield savings accounts generally offer more competitive interest rates compared to traditional savings accounts, allowing you to earn more on your deposited funds. However, the interest earned from these accounts is subject to taxation at your ordinary income tax rate.
How are money market deposit accounts taxed?
Money market deposit accounts generally offer high interest rates while providing liquidity for everyday transactions. Similar to high-yield savings accounts and CDs, the interest earned on money market deposit accounts is subject to taxation at your ordinary income tax rate.
How are CDs taxed?
Certificates of deposit (CDs) offer a safe investment option with potentially higher interest rates than traditional savings accounts. When you purchase a CD, you agree to lock in your funds for a specified period, known as the term. Interest accrues on the principal amount throughout the term, and upon maturity, you receive both the initial investment and accumulated interest.
Is CD interest taxable?
Yes, you do have to pay taxes on CD interest. When you earn interest on a CD, it is considered taxable income by the IRS. Here's a breakdown of how CD interest is taxed:
- Taxable income: CD interest is categorized as taxable income, similar to other forms of interest income, such as savings account interest or bond interest.
- Ordinary income tax rate: Just like with savings accounts, the interest earned on CDs is subject to taxation at your ordinary income tax rate, which is determined by your total taxable income for the year.
- Reporting requirements: Financial institutions that issue CDs typically provide investors with Form 1099-INT at the end of the tax year. This form reports the total amount of interest income earned on the CD during the year. Taxpayers must report this interest income on their federal income tax return (Form 1040 or 1040-SR) under the "Interest Income" section. Raisin customers receive consolidated tax documentation when they have earned $10 or more in interest via Raisin.
- Withholding: Some financial institutions may withhold taxes on CD interest payments, depending on the investor's tax status and the amount of interest earned. If taxes are not withheld, such as the case with products held in your Raisin account, CD interest is still considered taxable income and must be reported on the taxpayer's tax return.
- Penalty fees: If you withdraw funds from a CD before its maturity date, you may incur a penalty fee imposed by the financial institution. These penalty fees are not tax-deductible and are considered separate from the taxation of CD interest income.
How to avoid tax on CD interest
While you can't entirely avoid taxes on interest income, several strategies can help minimize the tax burden:
- Tax-advantaged accounts: One option would be investing in tax-advantaged accounts such as Individual Retirement Accounts (IRAs) or Health Savings Accounts (HSAs), if eligible. Interest earned within these accounts may grow tax-deferred or tax-free, depending on the account type and qualifying withdrawals.
- Tax-exempt investments: Explore investment options that offer tax-exempt interest income, such as municipal bonds issued by state and local governments. While the initial yields may be lower than taxable investments, the tax benefits can enhance overall returns, especially for investors in higher tax brackets.
- Tax-loss harvesting: If you incur investment losses in taxable accounts, strategically selling investments at a loss can offset taxable gains, including interest income, reducing your overall tax liability.
- Timing of interest payments: Coordinate the timing of interest payments to align with your tax situation. For example, if you anticipate a lower income in a particular year, consider deferring interest payments to the following tax year to reduce your taxable income.
Conclusion
Understanding how savings income is taxed is essential for sound financial planning. Whether you're earning interest from savings accounts, money market deposit accounts, or CDs, knowing the tax implications allows you to make informed decisions to optimize your financial strategy.
By employing tax-efficient strategies and leveraging tax-advantaged accounts, you could maximize your savings while minimizing the impact of taxation. While this guide provides valuable insights, consulting a tax professional is recommended for personalized advice tailored to your financial situation.
Raisin is proud to be your partner in optimizing your savings. We recommend consulting a tax professional to further assist with declaring interest income.
The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
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