How Are Savings Accounts Taxed?
In addition to investing and saving for retirement, it’s a good idea to have three to six months’ worth of expenses set aside in a high-interest savings account. This money will be easily accessible if you run into a financial emergency, and it can give you added peace of mind.
Even with a high-interest savings account, the amount of money you earn in interest will be pretty negligible. But did you know that the IRS considers the money you earn in interest on a savings account as income?
That means you’re responsible for paying taxes on that income. As you’re preparing for tax season, let’s look at the main things you need to know about how savings accounts are taxed.
IRS Tax Guidelines for Savings
When you file your yearly taxes, the IRS expects you to report any income you brought in that year. And many people don’t realize that their reported income includes the interest they earned from various savings accounts.
You’ll typically receive a 1099-INT tax form in the mail for income earned, but you’re still expected to report that income whether you receive the form or not.
Keep in Mind
If the IRS takes a closer look into your tax returns and discovers that you’ve been earning interest on a bank account you didn’t report, this can end badly for you. You can get hit with expensive fees, and the IRS could decide to investigate further to determine whether it was truly a mistake or an act of fraud.
So it’s important to know exactly what you need to report to the IRS come tax season. Any interest you earn from savings will be added to your earned and other taxable income and included in your adjusted gross income.
Examples of Taxable Interest
Most of the interest you earn from savings is considered taxable income by the IRS, though there are some exceptions. Here is an overview of what the IRS considers taxable income:
- Interest from most bank accounts: Any interest that you earn from a savings account, CD or money market account is considered taxable income.
- Interest from Treasury bills: If you earn interest on a Treasury bill, note or bond, you’ll have to pay federal taxes on this income. However, it’s exempt from state and local taxes.
- Interest from savings bonds: Any interest you earn from Series EE and Series I savings bonds are excluded. But other than that, you’ll have to pay taxes on interest earned on savings bonds.
- Additional interest: If you receive $600 or more in income from a business, you should receive a 1099-INT form in the mail. You’re responsible for paying taxes on that income.
How Different Types of Income Are Taxed
When it comes time to report your taxes, there are two different types of income you can report: earned and unearned income. Let’s look at a brief description of the two:
- Earned income: This is the money you make in exchange for doing work, either in your business or at a job. This includes the money you’re paid in wages, and also includes things like travel or meal reimbursements.
- Unearned income: Unearned income is money you make without performing a professional service. Interest, dividends, and financial gifts are all examples of unearned income. Or if you receive Social Security, unemployment, or retirement distributions, those are also examples of unearned income.
These examples may sound obvious, but it’s important to understand the difference between the two. If you forget to label something or label your income incorrectly, it can cause you big problems come tax season.
You’ll pay three different types of taxes on earned income: payroll taxes, state income taxes and federal income taxes. If you have a full-time job, your employer takes these taxes out before you ever receive a paycheck.
However, you don’t have to pay payroll taxes on unearned income. Instead, you’ll just pay income taxes based on the tax bracket you fell in for the year.
How Much Will I Have To Pay in Taxes?
The amount you’ll owe in taxes this year depends on your total taxable income for 2020 and your current tax filing status. Here are the marginal tax brackets for the 2020 income year:
|Marginal Tax Rate||Single||Married Filing Jointly|
Are There Tax-Free Savings Accounts?
By now you know that you’re responsible for paying taxes on the interest you earn from savings. But that leads to another question: Are there any tax-free savings accounts?
The answer is yes — you’ll receive certain tax advantages by saving your money in an individual retirement account. Let’s look at two different accounts you can consider.
An IRA savings account combines the features of a traditional savings account with an IRA. You’ll earn interest on your account, but the money is tax-deferred, which means you can let your money grow tax-free until retirement.
The only downside is that there are contribution limits with an IRA savings account. You can contribute up to $6,000 per year, plus an annual catch-up contribution of $1,000 if you’re over the age of 50.
With a traditional IRA, you’ll have to pay taxes on the money you save once you reach retirement age. The advantage to this is that you don’t have to pay upfront taxes, but you will have to pay taxes once you retire.
When you open a Roth IRA, however, you’ll fund the account with after-tax dollars. This means that when you reach retirement, you can withdraw tax-free earnings, which can be a big advantage if you expect to be in a higher tax bracket later in life.
If you’ve earned any money in interest from savings this year, you’re responsible for reporting that income to the IRS. Even if your earnings seem insignificant, you could face fines and penalties if you fail to report all of your earned and unearned income.
If you earn more than $10 in interest with a financial institution, you should receive a 1099-INT tax form in the mail. Then on your tax returns, you’ll report any taxable interest you’ve earned on your Form 1040.
If you need help navigating tax season this year, it may be useful to work with an accountant. A qualified accountant can walk you through the process and ensure that you’re reporting all of your earned and unearned income.
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- IRS. 2021. "Topic No. 403 Interest Received."
- IRS. 2021. "About Form 1099-INT, Interest Income."
- IRS. 2020. "IRS provides tax inflation adjustments for tax year 2020."
- IRS. 2020. "What is Earned Income?"