Yes, you pay federal income tax on savings account interest, and most states tax it too
Any interest your savings account earns counts as taxable income. The bank reports it to the IRS on a 1099-INT form, and you report it on your tax return. The amount varies by how much money you have in the account and the interest rate the bank pays—right now that's typically 4% to 5% APY at online banks, though it changes with Federal Reserve decisions.
You do not pay tax on the money you put in (your principal). You only pay tax on the interest the bank pays you for letting them use that money. If you earned $50 in interest over the year, that $50 is what gets taxed as income, not the full account balance.
Most states also tax savings interest as part of your state income tax, with a few exceptions. New Hampshire and Tennessee do not tax interest income. A handful of other states have limited exemptions for people over a certain age or with income below a threshold, but those are rare and narrow.
Key Takeaways
- Banks report savings interest to the IRS on Form 1099-INT, and you must report it on your federal tax return as ordinary income.
- You are taxed only on the interest earned, not on your original deposit or account balance.
- Most states tax savings interest as part of state income tax, though New Hampshire and Tennessee do not.
- Interest income is taxed at your ordinary income tax rate, which depends on your total income and filing status.
- If you earned less than $10 in interest in a year, the bank may not send a 1099-INT, but you still owe tax on it.
How the IRS finds out about your interest income
Your bank automatically reports interest to the IRS using Form 1099-INT. The bank sends you a copy and sends another to the IRS. This happens every January for interest earned in the previous calendar year. You do not have to ask the bank to report it—they do it for all accounts that earn interest.
If you earned less than $10 in interest, the bank may not be required to send a 1099-INT, but you still owe tax on that interest. The IRS expects you to report it on your return even if you do not receive the form. This is one reason to keep your own records of how much interest you earned each year.
If you have multiple savings accounts at different banks, each bank sends its own 1099-INT. You add up all the interest from all the forms when you file your return.
What tax rate applies to your interest income
Savings interest is taxed as ordinary income, meaning it is added to your wages, self-employment income, and any other income you earned that year. Your total income then determines which tax bracket you fall into, and that bracket determines your tax rate.
If you earned $50,000 in wages and $500 in savings interest, the IRS treats your taxable income as $50,500. That extra $500 may push you into a higher tax bracket, or it may not, depending on where you started. For most people, the tax on savings interest is somewhere between 10% and 24% of that interest, though it can be higher or lower depending on your situation.
This is different from long-term capital gains or may have access to dividends, which have their own lower tax rates. Savings interest does not get that break.
State income tax on savings interest
Most states tax savings interest the same way the federal government does—as ordinary income added to your total state taxable income. Your state tax rate then applies to that total.
Two states do not tax interest income at all: New Hampshire and Tennessee. A few other states have narrow exemptions—for example, Illinois does not tax interest earned by residents over 65, and Mississippi does not tax interest for residents over 59½—but these are exceptions, not the rule.
If you live in a state with income tax and earn interest, you will owe state tax on it unless you fall into a specific exemption your state offers. Check your state's tax agency website or your state tax form instructions to see whether an exemption applies to you.
When you receive the 1099-INT and how to use it
Banks mail 1099-INT forms by January 31 each year. The form shows the interest you earned in the previous calendar year. You use this form to fill out your tax return, whether you file with the IRS directly or use tax software.
If you use tax software, you enter the amount from Box 1 of the 1099-INT (labeled "Interest Income"). If you file by hand, you report it on Schedule B (Interest and Ordinary Dividends) if your interest is over $1,500, or directly on Form 1040 if it is $1,500 or less.
Keep your 1099-INT with your tax records for at least three years. If the IRS ever questions your return, you will need to show that you reported the interest correctly.
What happens if you do not report savings 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 mismatch between what you reported and what the bank reported. This can trigger a notice asking you to explain the difference, or in some cases, the IRS will calculate the tax you owe and send you a bill with penalties and interest.
Even small amounts of unreported interest can cause problems. It is easier and cheaper to report it correctly the first time than to deal with an IRS notice later.
Ways to reduce taxes on savings interest
You cannot avoid paying tax on savings interest, but you can reduce how much you earn and therefore how much you owe. One option is to keep money in a regular checking account that pays little or no interest, though this means giving up earnings. Another is to use a Roth IRA or other retirement account, where interest and other earnings grow tax-free (though there are contribution limits and rules about when you can withdraw).
Some people use a mix: keep emergency money in a high-yield savings account and accept the tax, and put longer-term savings into a retirement account where the interest is not taxed each year. This is a personal choice based on when you need the money and how much you have to save.
You cannot use a savings account to avoid taxes on other income, and you should not make financial decisions based solely on tax avoidance. The tax on savings interest is usually small compared to the interest you earn.
Frequently Asked Questions
Do I have to report savings interest if I earned less than $10?
Yes. Even if the bank does not send you a 1099-INT because the amount is under $10, you still owe tax on that interest. The IRS expects you to report all interest income, no matter how small. Keep track of your interest earnings yourself if the bank does not send a form.
What if I earned interest in a joint account with someone else?
The bank reports the full interest amount on a 1099-INT to whoever is listed as the primary account holder. If you and another person own the account jointly, you will need to decide how to split the interest for tax purposes. The IRS expects each person to report only their share. You may need to file a Form 8949 or attach a note to your return explaining the split.
Can I deduct savings account fees from the interest I report?
No. You report the full interest amount shown on the 1099-INT. You cannot subtract fees or other costs from it. However, if you paid investment fees or tax preparation fees related to managing your savings, you may be able to deduct those separately, though the rules are strict and most people do not benefit.
Do I pay taxes on interest if I withdraw money before the year ends?
Yes. You pay tax on all interest earned during the calendar year, regardless of when you withdraw the money or close the account. The 1099-INT will show interest earned from January 1 through December 31, even if you closed the account in June.
What if the bank sends me a 1099-INT with the wrong amount?
Contact the bank and ask them to send a corrected form (marked as a correction). Once they issue the corrected form, they also send a corrected copy to the IRS. Use the corrected amount on your tax return. If you already filed with the wrong amount, you can file an amended return using Form 1040-X.