When it comes to savings accounts, understanding how they are taxed is crucial. Essentially, savings accounts are subject to taxation based on the interest that they accrue. In simple terms, any interest you earn on your savings account is considered taxable income that must be reported to the IRS according to your tax bracket.
The Internal Revenue Service (IRS) views any interest earned as taxable income. Therefore, it is essential to report all interest earned on your tax return diligently.
Taxable income encompasses interest earned on various types of savings accounts, including traditional savings accounts, high-yield savings accounts (HYSA), certificates of deposits (CDs), and money market deposit accounts.
How Savings Accounts Are Taxable
Although savings accounts are not typically considered investments, they do generate income through interest. The IRS treats the interest from savings accounts as taxable income, regardless of whether you leave the money in the account, transfer it elsewhere, or withdraw it.
During the tax year when your bank deposits interest into your account, you are liable to pay taxes on it. The interest accrued in a savings account is taxed according to your earned income tax rate, which can range from 10% to 37% as per current tax year regulations.
Financial institutions usually provide a 1099-INT form early in the year for reporting any interest earned above $10. However, it is crucial to report all interest income, even amounts less than $10, regardless of whether you receive this form or not.
If your net investment income (NII) or modified adjusted gross income (MAGI) surpasses a specific threshold, your interest income may also be subject to the net investment income tax.
What’s Exempt From Tax
While the interest on savings accounts is taxable, the original deposited amount is not subject to tax since it has already been taxed.
For instance, if you have $10,000 in a savings account earning 0.2% interest, you are only taxed on the $20 in interest paid by the bank, not on the principal $10,000.
Exceptions to Taxes on Interest
Certain accounts, such as traditional and Roth individual retirement accounts (IRAs), allow the interest to grow tax-deferred. Earnings within tax-advantaged retirement accounts do not need to be reported annually as taxable income.
With a traditional IRA or 401(k), taxes are delayed until withdrawal post-retirement, when both the account balance and earnings are subject to income tax.
In the case of a Roth IRA, taxes are paid on deposits when made and withdrawals after age 59½ are tax-free, including both the principal and earnings.
How to File
Each year, your financial institution will issue a Form 1099-INT, detailing the interest earned in the previous year. This amount should be reported as taxable income on your tax return based on your income bracket.
Frequently Asked Questions (FAQs)
How is Savings Account Interest Taxed?
Interest from savings accounts is taxed at your earned income tax rate for the year. It is considered an addition to your overall earnings and taxed accordingly. Current tax rates range from 10% to 37%.
What Kind of Form Reports Savings Account Interest?
Each year, the bank providing your savings account sends you a Form 1099-INT, reporting interest earned in the preceding year. This form should be used to report taxable income from interest on your account.
Do I Have to Report Less than $10 in Tax?
According to the IRS, all taxable and tax-exempt interest earned must be reported on your federal income tax return, even if the amount is less than $10.
The Bottom Line
It is essential to be mindful of the taxation on interest received in savings accounts, as even small amounts are subject to tax implications. Paying taxes on savings account interest can impact your returns due to inflation. Consider comparing interest rates on savings accounts to find higher-yield options that can enhance your earnings.