Interest is taxed as ordinary income at your regular tax rate

Most interest you earn — from savings accounts, bonds, CDs, money market accounts, and loans you make to others — is taxed the same way as wages or salary. The IRS treats it as ordinary income, which means it's added to your other income and taxed at whatever tax bracket you fall into for the year.

The bank or financial institution that pays you interest will report it to the IRS on a Form 1099-INT. You report that same amount on your tax return. There's no separate calculation or lower rate; it's straightforward addition to your taxable income.

The only common exception is interest from municipal bonds issued by state and local governments, which is usually exempt from federal tax. But that's the rare case. Everything else — savings account interest, CD interest, bond interest from corporate or U.S. Treasury bonds — follows the ordinary income rule.

Key Takeaways

  • Interest income is reported on Form 1099-INT by the financial institution and added to your total income for the year.
  • You pay tax on interest at your ordinary income tax rate, not a special lower rate, regardless of how much interest you earn.
  • The IRS requires banks and investment firms to report interest of $10 or more, though you owe tax on all interest even if it's below that threshold.
  • Municipal bond interest is the main exception and is usually not taxed federally, but you still report it on your return.
  • Interest earned in tax-advantaged accounts like IRAs or 401(k)s is not taxed until you withdraw the money, which is a different rule from ordinary interest.

How the IRS knows about your interest income

Financial institutions send Form 1099-INT to both you and the IRS each January for interest paid in the previous year. If you earned $10 or more in interest from a single source, you'll receive the form. Some banks send it even for smaller amounts.

The IRS matches the 1099-INT they receive from the bank against what you report on your tax return. If you don't report interest that the bank reported, the IRS will notice. This is one of the most commonly caught mismatches because the reporting is automatic and consistent.

You are required to report all interest income on your return, even if you don't receive a 1099-INT form. If a bank fails to send one, or if you earned interest below the $10 reporting threshold, you still owe tax on it and should report it yourself.

Interest income and your tax bracket

Interest is added to your other income — wages, self-employment income, capital gains, and so on — to determine your total taxable income for the year. Your tax bracket is then applied to that total. This means interest can push you into a higher bracket if you're close to the edge.

For example, if you earn $50,000 in wages and $5,000 in interest, your taxable income is $55,000. You don't pay a special rate on the $5,000; instead, the entire $55,000 is taxed according to the tax brackets for your filing status. The interest is taxed at whatever marginal rate applies to that portion of your income.

This is different from long-term capital gains, which have their own lower tax rates. Interest gets no such preferential treatment — it's ordinary income all the way.

Interest in retirement accounts and savings plans

Interest earned inside a traditional IRA, 401(k), 403(b), or other tax-deferred retirement account is not taxed in the year it's earned. Instead, you pay tax on the entire withdrawal when you take money out in retirement. This is a major advantage of these accounts.

Interest in a Roth IRA or Roth 401(k) is also not taxed when earned, and if you follow the withdrawal rules, it's never taxed at all — not even in retirement. This makes Roth accounts especially valuable for interest-bearing investments.

Interest in a regular taxable savings account or investment account, by contrast, is taxed every year, even if you don't touch the money. This is why many people use retirement accounts for bonds and other interest-bearing investments when possible.

When you receive interest but don't get a 1099-INT

Some interest payments don't trigger a 1099-INT form. Interest from U.S. savings bonds, for instance, is not reported on a 1099-INT; instead, you report it when you cash in the bond or when it matures. Interest from certain state and local bonds also may not appear on a 1099-INT.

If you lend money to a friend or family member and they pay you interest, that interest is ordinary income to you, but the person paying it may not send you a 1099-INT. You're still required to report it on your return. The IRS expects you to track informal loans and report the interest yourself.

The absence of a 1099-INT does not mean the interest is tax-free. You report it anyway, usually on Schedule 1 (Other Income) of your Form 1040.

Interest from different sources

Interest works the same way regardless of where it comes from. A savings account at a bank, a money market fund, a bond you own, a CD, or interest from a loan you made — all are taxed as ordinary income. The source doesn't matter; the treatment does.

U.S. Treasury bonds, notes, and bills pay interest that is subject to federal tax but exempt from state and local tax. This is a small advantage compared to other bonds, but the interest is still ordinary income federally.

Corporate bonds, bond mutual funds, and bond ETFs all generate interest that is taxed as ordinary income. If the fund or ETF also distributes capital gains, those are taxed separately at capital gains rates, but the interest portion is ordinary income.

Frequently Asked Questions

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

Yes. The $10 threshold is only for when a bank must send you a 1099-INT form. You are required to report all interest income on your tax return, regardless of the amount. If you earned $3 in interest, you report it.

Is interest taxed differently if I'm retired?

No. Interest is taxed as ordinary income at your regular tax rate, whether you're working or retired. However, if you're over 65, you may be able to claim an additional standard deduction, which lowers your taxable income overall. The interest itself is still taxed the same way.

What if I earned interest in a joint account?

The person who receives the 1099-INT is responsible for reporting it. If the account is joint and the bank issues the form in one person's name, that person reports it. If you split the interest, you may need to file Form 8949 or work with a tax professional to allocate it correctly.

Can I deduct interest I paid on a loan?

Interest you pay is different from interest you earn. Interest paid on a mortgage is deductible if you itemize. Interest on most other loans — credit cards, personal loans, car loans — is not deductible. Interest you earn is always taxable; interest you pay may or may not be deductible depending on the type of loan.

Is interest from a savings bond taxed every year?

No. With U.S. savings bonds, you can choose to report the interest when you cash in the bond or when it matures, rather than every year. This is one of the few exceptions to the annual interest reporting rule. You report it all at once when the bond is redeemed.