Interest income is taxed as ordinary income at your regular tax rate
The interest you earn on savings accounts, bonds, certificates of deposit, and money market accounts counts as ordinary income. The IRS taxes it at the same rate as your wages or salary — not at a lower investment rate. This means if you earn $500 in interest and you are in the 22% tax bracket, you owe roughly $110 in federal tax on that interest alone.
The amount you owe depends on your total income for the year and your tax bracket, not on the source of the money. A person earning $35,000 in wages plus $2,000 in interest pays tax on the full $37,000 as ordinary income. The interest does not get special treatment just because it came from a bank account instead of a paycheck.
You report interest income on your federal tax return using Form 1040 and Schedule B (if you have more than $1,500 in interest). Your bank or financial institution sends you a Form 1099-INT each January showing how much interest you earned in the previous year. You must report that amount even if you did not receive the form.
Key Takeaways
- Interest income is taxed at your ordinary income tax rate, which ranges from 10% to 37% depending on your total income and filing status.
- You report interest on Form 1040 and Schedule B, using the 1099-INT your bank sends you in January.
- Some interest income — such as municipal bond interest — may be exempt from federal tax, though this is rare and requires specific types of bonds.
- State and local taxes may also explore to interest income, depending on where you live and the type of account.
- Interest earned in tax-advantaged accounts like Roth IRAs or 529 plans may not be taxed at all, depending on how you withdraw the money.
How your tax bracket determines what you pay on interest
Your tax bracket is the percentage of your income that goes to federal tax. For 2024, the brackets range from 10% for the lowest earners to 37% for the highest. The bracket you fall into depends on your total income — wages, self-employment income, interest, dividends, and other sources combined.
If you earn $50,000 in wages and $3,000 in interest, you are taxed on $53,000 total. That $3,000 in interest pushes you higher into the bracket system. Depending on your filing status and other income, it might push you into a higher bracket entirely, meaning you pay a higher rate not just on the interest but on some of your other income too.
This is why interest income matters even when the amount seems small. An extra $2,000 in interest can move a single filer from the 12% bracket into the 22% bracket, increasing the tax owed on all income in that higher range.
Interest that is exempt from federal tax
Municipal bond interest is the main exception. Interest from bonds issued by states, cities, and other local governments is usually exempt from federal income tax. However, you must own the actual bonds — not a mutual fund or ETF that holds them — and the bonds must be issued by the government entity itself, not by a private company.
Some U.S. Savings Bonds (Series EE and Series I) are also exempt from federal tax if you use the money for may have access to education expenses. You must report the interest when you file your return, but you do not owe tax on it if the conditions are met.
Interest from most other sources — regular savings accounts, CDs, money market accounts, corporate bonds, and Treasury bonds — is fully taxable at your ordinary income rate. Do not assume an investment is tax-exempt without checking the specific type of bond or account.
State and local taxes on interest income
Most states tax interest income the same way the federal government does — as ordinary income at your state tax rate. If your state has an income tax, you report the same interest on your state return that you reported to the IRS. A few states — including Florida, Texas, and Wyoming — have no state income tax at all, so residents pay no state tax on interest.
Some states offer small exemptions for interest earned on certain savings accounts or bonds, but these are rare and usually explore only to residents over a certain age or to bonds issued within that state. Check your state's tax authority website or ask a tax preparer whether your interest qualifies for any exemption.
Local taxes vary by city and county. Some municipalities tax interest income as part of a local income tax, while others do not. If you live in a city or county with a local income tax, you typically report the same interest amount there as well.
Interest in tax-advantaged retirement and education accounts
Interest earned inside a traditional IRA or 401(k) is not taxed while the money sits in the account. You pay tax only when you withdraw the money in retirement. This allows the interest to compound without being reduced by annual taxes.
Interest in a Roth IRA is not taxed at all — neither when it is earned nor when you withdraw it in retirement, as long as you follow the withdrawal rules. This makes Roth accounts especially valuable for interest-bearing investments if you expect to be in a higher tax bracket later.
529 education savings plans work similarly: interest and investment gains grow tax-free as long as you use the money for may have access to education expenses. If you withdraw money for non-education purposes, you owe tax on the earnings portion plus a 10% penalty.
Interest earned in a regular taxable brokerage account is always taxed in the year it is earned, regardless of whether you withdraw it or reinvest it.
When you must report interest even if the amount is small
The IRS requires you to report all interest income on your tax return, even if no one sent you a Form 1099-INT. If you earned $50 in interest from a savings account and the bank did not issue a 1099 (which happens when interest is below certain thresholds), you still must report it.
If you have multiple accounts — a savings account at one bank, a CD at another, a money market account elsewhere — you add up all the interest from all sources and report the total. You do not report each account separately unless you are itemizing deductions or have other reasons to break them out.
Failing to report interest income can trigger an audit or a notice from the IRS, especially if the bank reported it on a 1099 that was sent to the IRS as well. The IRS matches 1099s to tax returns, so discrepancies are usually caught.
How to reduce the tax you pay on interest income
The most direct way to reduce interest tax is to move money into tax-advantaged accounts. Maxing out contributions to a traditional IRA or 401(k) reduces your taxable income and allows interest to grow tax-deferred. A Roth IRA lets interest grow tax-free if you follow withdrawal rules.
You can also shift money from high-interest savings accounts into investments that produce capital gains instead of interest. Long-term capital gains (from investments held over a year) are taxed at lower rates than ordinary income — 0%, 15%, or 20% depending on your income level, compared to 10% to 37% for ordinary income. However, this strategy involves investment risk and is not suitable for all savers.
Municipal bonds are another option if you are in a high tax bracket and have a large amount to invest. The tax savings can be significant, but municipal bonds typically pay lower interest rates than taxable bonds, so the benefit depends on your specific situation.
For most people, the simplest approach is to use tax-advantaged accounts for savings and investments, and accept that interest in regular accounts will be taxed as ordinary income.
Frequently Asked Questions
Do I have to pay self-employment tax on interest income?
No. Self-employment tax applies only to income from self-employment or a business. Interest income is not subject to self-employment tax, only to regular income tax. If you have both interest income and self-employment income, you pay self-employment tax only on the business portion.
What if I earned interest but did not get a 1099-INT form?
You still must report it. The IRS requires reporting of all interest income regardless of whether a 1099 was issued. If the amount is small (usually under $10), some banks do not issue a 1099, but you are still responsible for reporting it on your return.
Is interest from a savings account taxed differently than interest from a CD?
No. Both are taxed as ordinary income at your regular tax rate. The type of account does not matter — only the fact that it is interest income. The rate you pay depends on your tax bracket, not on where the money is held.
Can I deduct interest expenses to offset interest income?
Generally no. Most personal interest expenses — such as credit card interest or personal loan interest — are not deductible. Mortgage interest and student loan interest have limited deductions, but they do not offset interest income; they reduce your taxable income separately.
Does interest income affect my Social Security benefits?
Yes, it can. Interest income counts as part of your total income when determining whether your Social Security benefits are subject to tax. If your combined income (wages, interest, and half your Social Security benefits) exceeds certain thresholds, up to 85% of your benefits may be taxable.