The IRS taxes the interest your savings account earns, not the balance itself

Your savings account balance—the money you deposited—is never taxed. The IRS taxes only the interest the bank pays you on that balance. If you have $10,000 in a savings account earning 4.5% annual interest, you owe tax on the roughly $450 in interest earned that year, not on the $10,000.

The bank reports this interest to both you and the IRS on a Form 1099-INT each January. If your account earned $10 or more in interest during the year, the bank must send you this form. You then report that interest as income on your federal tax return. The tax you owe depends on your overall income and your tax bracket—someone in the 22% bracket pays roughly 22% of the interest in federal tax, while someone in the 12% bracket pays roughly 12%.

State and local taxes may also explore. Some states tax interest income the same way the federal government does. Others tax it at a different rate or exempt it entirely. A few states—including Tennessee and Texas—do not tax interest income at all.

Key Takeaways

  • Banks report interest earned on your savings account to the IRS using Form 1099-INT, which you receive by January 31 if interest exceeded $10.
  • You report this interest as income on your federal tax return, and the tax owed depends on your tax bracket and total income for the year.
  • State and local taxes on savings interest vary widely—some states tax it, others do not, and rates differ where they do.
  • Interest earned in a traditional IRA or 401(k) is not taxed until you withdraw it, while interest in a Roth IRA grows tax-free if you follow withdrawal rules.

How the bank calculates and reports interest

Banks calculate interest daily or monthly, depending on the account terms, and add it to your balance. The interest rate varies by bank and account type—a high-yield savings account might pay 4% to 5%, while a standard savings account might pay 0.01%. The bank compounds the interest, meaning you earn interest on your interest once it is added to your balance.

By January 31 each year, the bank sends you Form 1099-INT showing the total interest paid into your account during the previous calendar year. The form goes to you and a copy goes to the IRS. If you have accounts at multiple banks, you will receive a separate 1099-INT from each one. You must report the total interest from all accounts on your tax return.

If interest falls below $10 for the year, the bank is not required to send a 1099-INT, but you still owe tax on that interest if you file a return. Keep your own records of interest earned if the bank does not report it.

What happens if you do not report the interest

The IRS receives a copy of every 1099-INT the bank sends you. If you do not report the interest on your tax return, the IRS will notice the discrepancy when it matches your return against the forms it received from banks. This can trigger a notice asking you to explain the difference or pay the tax owed plus penalties and interest.

The penalty for underreporting income is typically 20% of the underpaid tax, though it can be lower if you have reasonable cause. Interest accrues on unpaid taxes at a rate set quarterly by the IRS—currently around 8% annually. Intentional underreporting can result in fraud penalties of up to 75% of the underpaid tax.

Tax-advantaged accounts that reduce or eliminate interest taxation

A traditional IRA or 401(k) allows interest to grow without annual taxation. You do not report the interest each year. Instead, you pay tax on the entire withdrawal when you take money out in retirement. This defers the tax bill but does not eliminate it.

A Roth IRA works differently: interest grows tax-free, and you owe no tax on withdrawals in retirement if you follow the rules (you must be at least 59½ and have held the account for at least five years). This makes a Roth IRA the most tax-efficient option for long-term savings, though contributions are limited—$7,000 per year for most people in 2024, with higher limits for those 50 and older.

A 529 college savings plan also allows interest to grow tax-free if the money is used for may have access to education expenses. If you withdraw funds for non-education purposes, you owe tax on the interest portion plus a 10% penalty.

How your tax bracket affects what you owe on interest

Interest income is taxed as ordinary income, meaning it is added to your wages, self-employment income, and other sources of income to determine your tax bracket. If you earn $50,000 in wages and $500 in savings interest, the IRS treats you as having $50,500 in taxable income.

This can push you into a higher tax bracket. If you are near the edge of a bracket—say, $47,150 in wages when the 22% bracket starts at $47,150—an extra $500 in interest moves you into the higher bracket, and that $500 is taxed at 22% instead of 12%.

The federal tax brackets change each year. For 2024, single filers in the 12% bracket earn up to $11,600; the 22% bracket runs from $11,601 to $47,150. Married filers have higher thresholds. Your actual tax owed also depends on deductions, credits, and whether you file as single, married, or head of household.

State and local taxes on savings interest

Most states that have an income tax also tax interest income. The state tax rate is usually separate from the federal rate. New York, for example, taxes interest at rates up to 6.85% depending on income. California taxes it at up to 13.3%. Some states have lower rates—Indiana taxes interest at a flat 3.23%.

A handful of states do not tax interest income at all. These include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. If you live in one of these states, you owe only federal tax on savings interest.

Local taxes vary by city and county. Some municipalities in states like Ohio, Pennsylvania, and Maryland impose local income taxes that include interest. Check your state and local tax authority websites to understand what applies where you live.

Strategies to reduce interest income taxation

The most straightforward approach is to use tax-advantaged accounts for savings you plan to keep long-term. A Roth IRA lets interest grow completely tax-free if you follow the withdrawal rules. A traditional IRA or 401(k) defers the tax until retirement, which may put you in a lower bracket.

If you have savings outside retirement accounts, consider whether you need the money within five years. If not, a 529 plan (if you have children or grandchildren) or a Roth IRA (if you meet income limits) can shelter the interest from tax. For money you need to access sooner, a high-yield savings account in a regular taxable account still makes sense—the interest rate is high enough that the tax is worth paying.

You cannot avoid reporting interest income, but you can structure where you hold savings to minimize the tax you owe. Someone with $100,000 in savings might put $7,000 in a Roth IRA, $23,500 in a traditional IRA (if they have earned income and do not exceed income limits), and the remaining $69,500 in a high-yield savings account. The interest on the first two grows tax-free or tax-deferred, while the interest on the third is taxed as ordinary income.

Frequently Asked Questions

Do I have to report interest if I earned less than $10?

The bank does not have to send you a 1099-INT if interest was under $10, but you still owe tax on it if you file a return. Keep your own records of interest earned and report it on your tax return even if the bank does not report it to the IRS.

What if I have multiple savings accounts at different banks?

Each bank sends a separate 1099-INT. You add up the interest from all of them and report the total on your tax return. The IRS receives copies of all the forms, so it will know if you miss any.

Can I deduct savings account interest as a loss?

No. Interest income is taxed as ordinary income, but you cannot deduct it as a loss. You report it as income, period.

Is interest from a money market account taxed the same way as a savings account?

Yes. Money market accounts, savings accounts, and certificates of deposit (CDs) all report interest on Form 1099-INT and are taxed as ordinary income. The only difference is the interest rate and how quickly you can access the money.

What if the bank made an error on my 1099-INT?

Contact the bank and ask for a corrected form (Form 1099-INT with a "CORRECTED" box checked). The bank sends the corrected form to you and the IRS. If you already filed your return, you may need to file an amended return (Form 1040-X) to correct your reported income.