You pay income tax on savings account interest, not on the money you deposit

The interest your bank pays you on a savings account is taxed as ordinary income by the federal government and, in most states, by your state too. You do not pay tax on the principal—the money you put in—only on the earnings. The tax rate depends on your total income for the year and your tax bracket, which ranges from 10% to 37% at the federal level.

Your bank reports this interest to the IRS on a Form 1099-INT if you earned $10 or more in interest during the tax year. You receive a copy by January 31, and you must report it on your tax return. If you earned less than $10, the bank does not have to send a form, but you still owe tax on the interest if you file a return.

The amount of tax you actually pay depends on your income bracket and whether you itemize deductions or take the standard deduction. A person in the 22% federal bracket who earns $500 in savings interest will owe roughly $110 in federal tax on that interest alone, though state tax varies widely.

Key Takeaways

  • Interest earned in a savings account is taxed as ordinary income at your marginal tax rate, which can range from 10% to 37% federally depending on your total income.
  • Your bank sends you a Form 1099-INT by January 31 if you earned $10 or more in interest, and you must report this on your federal tax return.
  • State income tax on savings interest varies by state—some states do not tax it, while others tax it at rates between 1% and 13%.
  • High-yield savings accounts earn more interest but are taxed the same way as regular savings accounts, so the tax bill is larger even though the rate is identical.

How the IRS taxes interest income

Interest is treated as ordinary income, which means it is added to your wages, self-employment income, and other earnings to determine your tax bracket for the year. If you earn $60,000 in wages and $500 in savings interest, the IRS treats your taxable income as $60,500. You pay tax on that $500 at whatever marginal rate applies to the top of your income—not at a special lower rate.

The federal tax brackets for 2024 range from 10% on the first portion of income to 37% on income above $191,950 (for single filers). A person earning $40,000 per year falls into the 22% bracket, so each dollar of savings interest is taxed at 22%. Someone earning $200,000 falls into the 35% bracket, so their savings interest is taxed at 35%.

This is different from long-term capital gains, which are taxed at lower rates (0%, 15%, or 20% depending on income). Savings account interest never qualifies for capital gains treatment, no matter how long you hold the account.

State and local taxes on savings interest

Most states tax savings interest as ordinary income, but the rates and rules vary significantly. New York taxes it at rates up to 6.85%. California taxes it at rates up to 13.3%. Some states, including Texas, Florida, and Nevada, do not have a state income tax at all, so residents pay no state tax on savings interest.

A few states exempt interest income from taxation entirely. Tennessee and New Hampshire do not tax interest or dividend income, though they do tax wages. If you live in one of these states, you owe federal tax on savings interest but not state tax.

Some cities also impose local income taxes that apply to interest. New York City, for example, taxes residents on savings interest at rates up to 3.876%. Check your state and local tax authority websites to find the exact rate where you live.

When you receive the Form 1099-INT

Your bank or financial institution sends you a Form 1099-INT by January 31 each year if you earned $10 or more in interest during the previous calendar year. The form shows the total interest paid to you in box 1. If you earned interest from multiple accounts at the same bank, the total from all accounts is combined on one form.

You receive two copies: one to keep for your records and one to submit with your tax return. The IRS also receives a copy directly from your bank, so if you do not report the interest on your return, the IRS will notice the discrepancy.

If you earned less than $10 in interest, your bank is not required to send a Form 1099-INT. However, you still owe tax on that interest if you file a return. Keep your own records of interest earned so you can report it accurately.

How to report savings interest on your tax return

You report savings interest on Schedule 1 (Form 1040) under "Interest." Add up all interest from all sources—savings accounts, money market accounts, CDs, bonds, and any other interest-bearing accounts—and enter the total on line 8 of Schedule 1. This amount then flows to your Form 1040 and becomes part of your adjusted gross income.

If you use tax software, it will usually prompt you to enter the amount from your 1099-INT forms. If you file by hand, write the total on the line and attach your 1099-INT copies to your return.

If you have a joint account with a spouse or another person, the interest is typically split between you based on your ownership share. Your bank may issue separate 1099-INT forms to each owner, or one form with the full amount. Check with your bank about how they report joint account interest.

High-yield savings accounts and tax

A high-yield savings account earns more interest than a regular savings account—sometimes 4% to 5% annually compared to 0.01% or less at traditional banks. However, the interest is taxed exactly the same way. The higher interest means a larger tax bill, not a lower tax rate.

If you earn $2,000 in interest from a high-yield account, you report all $2,000 as income and pay tax on it at your marginal rate. The bank still sends a 1099-INT, and you still report it on Schedule 1. The only difference is the dollar amount of interest and therefore the dollar amount of tax owed.

This is why some people use high-yield savings accounts in tax-advantaged accounts like IRAs or 401(k)s, where the interest grows tax-free. In a regular taxable account, the higher interest rate is offset by the higher tax bill.

Strategies to reduce tax on savings interest

You cannot avoid tax on savings interest, but you can reduce it by holding money in tax-advantaged accounts. A traditional IRA or 401(k) allows interest to grow without annual taxation. You pay tax only when you withdraw the money in retirement. A Roth IRA allows interest to grow completely tax-free if you follow the withdrawal rules.

For money you need to access before retirement, a 529 college savings plan lets interest grow tax-free if used for education expenses. A Health Savings Account (HSA) offers tax-free growth for medical expenses.

If you have a large amount in savings and want to minimize tax, you might also consider keeping some money in a money market fund or short-term bond fund instead of a savings account. These investments may offer tax-exempt interest (municipal bonds) or long-term capital gains treatment, though they carry different risks than savings accounts.

What happens if you do not report savings interest

If you do not report savings interest on your tax return, the IRS will likely catch it because your bank reports it on a 1099-INT. The IRS matches 1099 forms to tax returns and flags missing income. You will receive a notice of underreported income, and the IRS will assess back taxes, interest, and potentially penalties.

The penalty for negligence is typically 20% of the underpaid tax. If the IRS determines the underreporting was intentional fraud, the penalty can be as high as 75%. Interest accrues on unpaid taxes from the original due date, compounding the amount owed.

If you discover you missed reporting interest from a prior year, you can file an amended return using Form 1040-X. Filing an amended return voluntarily is much better than waiting for the IRS to contact you, as it shows good faith and may reduce penalties.

Frequently Asked Questions

Do I owe tax on savings interest if I do not withdraw it?

Yes. You owe tax on interest in the year it is earned and credited to your account, whether you withdraw it or leave it to compound. The IRS taxes interest income on an accrual basis, not a cash basis.

What if I have savings accounts at multiple banks?

Each bank sends you a separate 1099-INT if you earned $10 or more at that bank. You add up all the interest from all banks and report the total on Schedule 1 of your tax return.

Is savings interest taxed differently if I am retired?

No. Savings interest is taxed as ordinary income regardless of your age or employment status. However, if your total income is low enough, you may not owe any tax. Retirees with income below the standard deduction threshold do not owe federal tax.

Can I deduct savings account fees from the interest I report?

No. You report the gross interest paid by the bank on your 1099-INT, and you cannot reduce it by fees. However, if you paid investment advisory fees or tax preparation fees related to managing your savings, you may be able to deduct those separately if you itemize deductions, though the rules are strict.

What if the bank made an error on my 1099-INT?

Contact the bank immediately and ask for a corrected form. The bank will issue a corrected 1099-INT and send it to the IRS. You should also file an amended return if you already filed based on the incorrect amount. Keep documentation of the error and the correction.