Interest from your savings account counts as income, and you owe federal tax on it

The interest your bank pays you is taxable income. The IRS treats it the same way it treats wages or freelance earnings — money that comes into your hands is money you report. You will owe federal income tax on every dollar of interest your account earns, no matter how small the amount. Some states also tax interest income, depending on where you live.

The tax you owe depends on your total income for the year and your tax bracket. If you earn $500 in interest and your marginal tax rate is 22%, you owe roughly $110 in tax on that interest. If your rate is 12%, you owe roughly $60. The bank does not withhold this tax automatically — you report it yourself when you file your return, or you may need to make quarterly estimated tax payments if the interest is substantial.

Banks report interest to the IRS on a Form 1099-INT, which they send to you and to the IRS by January 31 each year. If you earned $10 or more in interest during the tax year, you will receive this form. The IRS cross-checks your return against the 1099-INT they receive from the bank, so reporting the interest is not optional.

Key Takeaways

  • Interest income is taxable at your ordinary income tax rate, which ranges from 10% to 37% depending on your total earnings and filing status.
  • Banks report interest of $10 or more on Form 1099-INT, which the IRS receives and matches against your tax return.
  • You report interest income on your federal return even if you do not receive a 1099-INT, and some states tax it as well.
  • High-yield savings accounts earn more interest than traditional accounts, which means higher tax liability on the earnings.

How the IRS taxes interest at your marginal rate

The tax you pay on interest depends on your marginal tax bracket — the rate applied to your last dollar of income. If you are single and earned $45,000 in wages, you are in the 22% bracket for 2024. Interest you earn gets added to that $45,000, and the interest portion is taxed at 22%. If you earned $200,000, you are in the 35% bracket, and your interest is taxed at 35%.

This matters because high-yield savings accounts now pay 4% to 5% annual interest. On $50,000 in savings, that is $2,000 to $2,500 per year in interest. At a 22% tax rate, you owe $440 to $550 in federal tax on that interest alone. At a 35% rate, you owe $700 to $875. The higher your income, the more tax you pay on the same interest earnings.

Some people think of interest as "information programs" and are surprised when they owe tax on it. It is not free — it is income, and income is taxable. The bank is paying you for the use of your money, and that payment is subject to tax like any other payment for a service or asset.

State income tax on interest varies by location

Nine states have no income tax at all: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming, and New Hampshire (which taxes interest and dividends but not wages). If you live in one of these states, you owe no state tax on savings interest, only federal tax.

Every other state taxes interest as ordinary income. The state rate varies — from 3% in some states to over 13% in others. A few states offer small exemptions for interest earned by retirees or people over a certain age, but these are narrow and do not explore to most savers. Your state tax bill is separate from your federal bill and is calculated on the same interest income the IRS sees on your 1099-INT.

If you live in a high-tax state and earn substantial interest, the combined federal and state tax can be significant. Someone in California earning $2,000 in interest at a 35% federal rate and 13.3% state rate pays roughly $960 in total tax on that interest — nearly half the earnings.

When you have to report interest even without a 1099-INT

The IRS requires you to report all interest income on your tax return, whether or not you receive a 1099-INT. If you earned less than $10 in interest, the bank does not send you a form, but you still owe tax on it. If you have multiple savings accounts at different banks and each earns $8, you earned $16 total and must report it.

The IRS knows about your interest because banks report it electronically. If you do not report interest that the bank reported, the IRS will notice the discrepancy. The penalty for underreporting is typically 20% of the underpaid tax, plus interest on the unpaid amount, plus potential fraud penalties if the IRS determines it was intentional.

If you use tax software or work with a tax preparer, they will ask you for all 1099-INT forms and any other interest income. Be thorough — include interest from savings accounts, money market accounts, certificates of deposit, and any other accounts that paid you interest during the year.

How to calculate your tax liability on interest

Start with your total income for the year: wages, self-employment income, investment income, and interest. Add your interest earnings to that total. Look up your tax bracket based on your filing status and total income. Multiply your interest by the tax rate in that bracket to find your federal tax on the interest.

For example: You earned $60,000 in wages and $1,200 in interest. Your total income is $61,200. For a single filer in 2024, that puts you in the 22% bracket. Your federal tax on the interest is $1,200 × 0.22 = $264. If you live in a state with a 6% income tax, you owe an additional $1,200 × 0.06 = $72 in state tax. Your total tax on the interest is $336.

This is a simplified calculation. Your actual tax depends on deductions, credits, and other factors. If you have substantial interest income or a complex tax situation, a tax professional can give you a precise figure. Many offer free consultations to discuss your situation.

Strategies to reduce taxable interest income

You cannot avoid tax on interest, but you can reduce the amount of interest you earn and therefore the tax you owe. One option is to keep some money in a regular savings account that pays little or no interest, reducing your total interest income. This is rarely a good trade-off — the tax savings are small compared to the interest you give up.

A more practical approach is to use tax-advantaged accounts. Money in a traditional IRA or 401(k) earns interest that is not taxed until you withdraw it in retirement. Money in a Roth IRA or Roth 401(k) earns interest that is never taxed. If you have earned income, you can contribute to these accounts and shelter some of your savings from current-year tax.

Another option is to use a Health Savings Account (HSA) if you are enrolled in a high-deductible health plan. Interest earned in an HSA is not taxed as long as you use the money for medical expenses. For people with substantial savings and high interest income, these accounts can meaningfully reduce tax liability.

Treasury bonds and municipal bonds offer tax advantages as well. Interest from U.S. Treasury securities is exempt from state and local tax. Interest from municipal bonds issued in your state is exempt from both federal and state tax. These typically pay lower interest rates than savings accounts, so the tax benefit may or may not make them worthwhile for you.

What happens if you do not report interest income

The IRS matches tax returns against 1099-INT forms reported by banks. If your return shows no interest income but the bank reported interest to the IRS, the IRS will send you a notice asking why. You will have to respond and either file an amended return or explain the discrepancy.

If you do not respond or do not amend your return, the IRS will assess the unpaid tax plus a penalty. The accuracy-related penalty is 20% of the underpaid tax. If the IRS determines the omission was fraudulent, the penalty rises to 75%. You will also owe interest on the unpaid tax, calculated from the original due date of your return. Over several years, these penalties and interest can exceed the original tax bill.

The simplest approach is to report all interest income when you file. It takes a few minutes and keeps you in compliance with the law.

Frequently Asked Questions

Do I owe tax on interest if I earned less than $10?

Yes. The bank does not send you a 1099-INT for interest under $10, but you still owe tax on it. The IRS requires you to report all interest income, regardless of amount. If you have multiple accounts that each earned less than $10, add them together and report the total.

Can I deduct the tax I pay on interest from my interest income?

No. Interest income is reported as gross income, and the tax you owe is calculated on that gross amount. You cannot reduce your taxable interest by the amount of tax you will pay. However, if you paid tax on interest in a prior year and it turns out you overpaid, you can claim a refund when you file your return.

What if I move to a different state during the year?

You owe tax to both states on a prorated basis. If you lived in a no-tax state for six months and a high-tax state for six months, you report half your interest to each state. Your tax software or a tax professional can calculate the split for you based on the dates you moved.

Is interest from a money market account taxed differently than interest from a savings account?

No. The IRS taxes all interest income the same way, regardless of the account type. Interest from savings accounts, money market accounts, certificates of deposit, and any other interest-bearing account is reported on Form 1099-INT and taxed at your ordinary income rate.

Do I owe tax on interest if I reinvest it instead of withdrawing it?

Yes. You owe tax on interest in the year it is earned, whether you withdraw it, leave it in the account, or reinvest it. The IRS taxes interest when the bank credits it to your account, not when you spend or move the money. This applies to all types of accounts and all types of interest.