You pay federal income tax on savings account interest, but not on the principal you deposit
The money you put into a savings account is not taxable — that is your own money. But the interest your bank pays you on that balance is taxable income. The IRS treats it the same way it treats wages or other money you receive. Your bank reports this interest to the IRS on a Form 1099-INT, and you report it on your tax return.
How much tax you owe depends on your total income and your tax bracket, not on the interest amount alone. A person in the 22% tax bracket pays more tax on $100 of interest than someone in the 10% bracket. Some states also tax savings interest, though a few do not.
The threshold for reporting is low: if you earned $10 or more in interest during the year, your bank must send you a 1099-INT. You must report the interest even if you do not receive a form, though in practice the IRS usually knows about it because your bank reported it.
Key Takeaways
- Banks report savings interest to the IRS on Form 1099-INT when you earn $10 or more in a calendar year.
- You owe federal income tax on all interest at your marginal tax rate, regardless of whether you withdraw it or leave it in the account.
- Some states tax savings interest and some do not; check your state's rules if you live outside a no-tax state.
- Interest earned in a traditional IRA or 401(k) is not taxed until you withdraw it; interest in a Roth IRA is never taxed.
- High-yield savings accounts pay more interest, which means more tax, but the after-tax return is usually still higher than regular savings accounts.
How the IRS knows about your savings interest
Your bank is required to report interest to both you and the IRS. In early February, the bank sends you a copy of Form 1099-INT showing the total interest paid to you during the previous calendar year. The bank sends an identical copy to the IRS.
When you file your tax return, you report this interest on Schedule 1 (Form 1040) under "Interest." The IRS matches what you report against what the bank reported. If the numbers do not match, the IRS will contact you.
You must report interest even if you do not receive a 1099-INT form. This can happen if you moved and the bank mailed the form to an old address, or if the bank made an error. If you do not receive the form by early February, contact your bank and ask for a copy or a corrected one.
When you do not owe tax on savings interest
Interest held in certain retirement accounts is not taxed in the year it is earned. In a traditional IRA or 401(k), interest and growth accumulate tax-free until you withdraw the money in retirement. In a Roth IRA, interest is never taxed at all, even when you withdraw it.
If you have a savings account in the name of a minor child, the child owes tax on the interest, not the parent. However, the first $1,250 of unearned income (interest, dividends, capital gains) is not taxed if the child has no other income and is claimed as a dependent. Interest above that threshold is taxed at the child's rate. This rule changes each year, so check the current threshold on the IRS website.
Interest in a 529 college savings plan is not taxed as long as the money is used for may have access to education expenses. If you withdraw it for other purposes, you owe tax on the earnings portion plus a 10% penalty.
State taxes on savings interest
Most states tax savings interest as ordinary income. Your state tax rate is added on top of your federal rate. A few states do not tax interest income at all: Alaska, Florida, Illinois, Mississippi, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming have no state income tax. New Hampshire and Tennessee tax only interest and dividends, not wages.
If you live in a state that taxes interest, you report it on your state tax return. Some states have a separate form for interest income; others include it on the main return. Check your state's tax authority website for the specific form and instructions.
If you moved during the year, you may owe tax to two states — the state where you lived for part of the year and the state where you lived at year-end. Most states have a credit to prevent double taxation, but you have to claim it on your return.
High-yield savings accounts and tax
A high-yield savings account pays more interest than a regular savings account — sometimes 4% to 5% annually, compared to 0.01% at a traditional bank. This higher interest is taxable just like any other interest. If you have $50,000 in a high-yield account earning 4.5%, you owe tax on $2,250 of interest that year.
Even though the tax bill is higher, the after-tax return is usually still better than a regular savings account. If you are in the 22% federal tax bracket plus a 5% state tax bracket, you pay 27% tax on the interest. On $2,250 of interest, that is $607.50 in tax, leaving you with $1,642.50 — far more than the $0.50 you would earn in a regular savings account.
The tax is owed whether you withdraw the interest or leave it in the account. If you leave the interest in the account, it earns more interest the following year, and you owe tax on that too. This is called compounding, and it works in your favor over time despite the tax cost.
Reporting interest on your tax return
If you have only one savings account and earned less than $1,500 in interest, you can report the total on Schedule 1 of Form 1040 without itemizing. Write the amount on the line for "Interest" and attach the 1099-INT form to your return.
If you have multiple accounts or earned more than $1,500 in interest, you must use Schedule B (Form 1040) to list each account separately. This form asks for the account holder's name, the financial institution, and the interest amount. You then transfer the total to Schedule 1.
If you file electronically, the software usually handles this automatically — you enter the 1099-INT information and the program puts it in the right place. If you file by paper, make sure you attach the 1099-INT to your return or the IRS may contact you asking for proof.
What happens if you do not report savings interest
The IRS receives a copy of every 1099-INT your bank sends. If you do not report the interest on your return, the IRS will notice the discrepancy. You will receive a notice asking you to explain the difference and pay the tax owed, plus interest on the unpaid amount.
If the IRS determines you intentionally did not report the interest, you may owe a penalty of 20% of the unpaid tax. If the IRS believes it was fraud, the penalty can be as high as 75%. In practice, most people who miss interest income do so by accident, and the IRS usually assesses only the tax and interest, not the penalty.
If you realize you missed reporting interest in a prior year, you can file an amended return using Form 1040-X. It is better to do this yourself than to wait for the IRS to contact you, because the IRS is more likely to waive penalties if you correct the error voluntarily.
Frequently Asked Questions
Do I owe tax on interest I did not withdraw?
Yes. The IRS taxes interest in the year it is credited to your account, whether you withdraw it or leave it there. If your bank paid you $500 in interest on December 31, you owe tax on that $500 even if you do not touch the money until next year.
What if I earned less than $10 in interest?
Your bank does not have to send you a 1099-INT if you earned less than $10. However, you still owe tax on the interest if your total income is high enough to require a return. Report it on your return even if you do not have a form.
Can I deduct savings account fees from the interest I report?
No. You report the full interest amount on your tax return. You cannot subtract fees, even if the bank charged you a monthly maintenance fee that reduced your net earnings. However, investment fees and advisory fees may be deductible in some cases — check with a tax professional.
Do I owe tax on interest from a joint savings account?
Yes, and you and the co-owner must decide how to split the tax. The bank typically reports the full interest to the IRS under one person's Social Security number. You and the co-owner should agree on how to divide the interest and report your share on your return. If you disagree, the IRS may contact both of you.
What if I moved to a different state during the year?
You may owe tax to both states. File a part-year resident return in the state you left and a resident return in the state you moved to. Most states have a credit to prevent double taxation, but you have to claim it. Contact both state tax authorities for the specific forms and instructions.