What Is Taxable Interest Income?

Taxable interest is any interest that is subject to federal income tax. Or, in layman’s terms, it is a levy applied to income/returns that you may have obtained from interests. The IRS taxes all interest incomes unless the returns fall under the tax exemption bracket. So what does a taxable interest income entail? Continue reading to learn more.

What Is the Tax Rate on Interest Income That I Must Pay?

The amount of tax that you have to pay will depend on your income level. If you are under the age of 65, it’s likely that your interest income will be included in the “taxable income” part of your tax return and assessed at your highest marginal rate. 

However, if you’re over 65 years old and receive most of your income from investments and pension payments, this may not apply to you (depending on whether or not these sources are considered “earned” income).

If a person earns more than $400 in net self-employment income during the year (which includes interest), they must also pay self-employment taxes. It is similar to an employer deducting FICA taxes from an employee’s paycheck.

When calculating their total taxable income, self-employed people can deduct half of the self-employment tax from their adjusted gross income (AGI). However, only 80% or less can be deducted for regular filers with AGIs above $125k. Additionally, married couples filing jointly with AGIs over $200k should also file their returns.

What Types of Interest Income Are Taxable?

Here’s the rundown of the types of taxable interest income:

  • Interest earned from bank accounts, including checking and savings, is taxable. However, there are some exceptions to this rule. For example, if you have a retirement account that generates interest and you’re over age 59½ or disabled, any interest earned in it is not taxable.
  • Interest earned on money market accounts or CDs also counts as taxable income. These funds are considered liquid assets because one can withdraw without penalty. Therefore, they don’t have tax benefits like retirement plans. The same goes for bonds purchased through traditional stock brokerages and municipal bonds issued by state or local governments (think bond funds).

Click here to learn more about how the IRS categorizes interest incomes.

In General, Interest Is Taxable to the Person Who Receives It. However, There Are Some Exceptions

If you receive interest from a retirement account or bond issued by a state or local government and specific organizations, that interest won’t be taxable.

Accelerated payment of tax-free public utility dividends or refunds of Federal unemployment tax paid on wages is subject to self-employment taxes. In both cases, you are not required to file Form 1040. (SE tax). Your accrued interest will not be taxed as long as you have used those payments for qualified purposes within 60 days of receiving them. 

Avoid Fines!

Taxable interest income is a little complicated. Understanding what it is is important because this information can help you make better financial decisions. You can save money by avoiding certain investments or loans based on what kind of interest they pay!

Adam Hansen

Adam is a part time journalist, entrepreneur, investor and father.