Tax must be paid by investors who receive interest income from their bonds, mutual funds, certificate of deposits (CDs) and demand deposit accounts. Some interest is fully taxable, while other forms are partially taxable. This article will break down the different types of interest and how each kind is taxed, as well as what forms you need in order to correctly report them.

Types of Interest Income
The following are the main types of interest income:

  • Interest from CDs, corporate bonds and some types of government agency securities
  • Checking, savings or other interest-bearing accounts
  • U.S. government obligations. These are taxable at the federal level only; municipal bond interest is exempt from taxation of any kind, unless the alternative minimum tax (AMT) applies.

How Is Taxable Interest Taxed?
Regular taxable interest is taxed as ordinary income, just like an individual retirement account (IRA) or retirement plan distribution. This means that the interest will be taxed at the taxpayer's top marginal tax rate. For example, if a taxpayer is in the 33% tax bracket, then all of his or her interest income will be taxed at 33%. This rule applies for interest that is both fully taxable at all levels and also for interest that is taxable only at the federal level.

Which Forms Do I Use?

Any payer of investment income must issue a Form 1099-INT to all recipients because it shows the amount and type of interest that was paid during the year. Any investor that receives a Form 1099-INT must be able to transcribe the information correctly on to the Schedule A & B Internal Revenue Service (IRS) Form.

What Do These Boxes Mean?
The 1099-INT form has several different boxes that list various types of interest income. The following is a brief list of the kind of income that is reported in each box:

Box 1

: Interest Income - The amount of regular interest that has been paid from fully taxable instruments, such as corporate bonds, mutual funds, CDs and demand deposit accounts.

Box 2

: Early Withdrawal Penalty - The total amount of early withdrawal penalties from CDs or other securities that you paid during the year. This amount is considered an above-the line deduction on the 1040.

Box 3

: Interest on U.S. Savings Bonds and Treasury Obligations - This number goes on a different line on the Schedule B because it is only taxable at the federal level. The income in this box is separate from the income in

Box 1

.

Box 4

: Federal Income Tax Withheld - The total amount of backup withholding on your interest income. Most interest payers must withhold tax at a 28% rate if the investor either failed to provide his or her tax ID, Social Security number (SSN) or provided an incorrect number. This number is added to the amount of withholding from your employer on the 1040.

Box 5

: Investment Expenses - The total amount of deductible expenses relating to your investment income from a single-class real estate mortgage investment conduits (REMIC). This figure can be added to any amount in

Box 2

and carried to the Schedule A as a miscellaneous investment expense.

Box 6

: Foreign Tax Paid - Any tax on your interest income that has been paid to a foreign country. If the foreign country has a tax treaty with the United States, this tax is usually either a deduction, or a credit.

Box 7

: Foreign Country or U.S. Possession - The foreign entity to which the tax in

Box 6

was paid.

Box 8

: Tax-Exempt Interest - Any interest that is exempt from all levels of tax for any reason, including tax-free dividends from mutual funds or other regulated investment companies. This figure is reported on line 8b of the 1040.


Box
9

: Specified Private Activity Bond Interest - This box reflects tax-exempt interest that is subject to AMT. This amount is also included in

Box 8

.

Each payer of interest will issue a separate 1099-INT to its investors. Investors will report all of the interest income received for the year on Part 1 of Schedule B of the 1040.

Conclusion
There are many more rules pertaining to interest income that lie beyond the scope of this article. For more information, readers should consult their tax advisor or download the instructions for Schedule B from the IRS website.

Related Articles
  1. Investing Basics

    Explaining Unrealized Gain

    An unrealized gain occurs when the current price of a security exceeds the price an investor paid for the security.
  2. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  3. Professionals

    The Rich Get Richer: Global Wealth is Rising

    Global wealth is rising and expected to continue. Advisors should know that the wealthy value fee transparency, performance.
  4. Investing News

    How 'Honesty' Could Pay off for Jessica Alba

    Is it possible that Jessica Alba is one of the savviest businesswomen on the planet?
  5. Term

    What is Wealth Management?

    Wealth management combines financial and investment advice, accounting and tax services, and legal and estate planning.
  6. Professionals

    Wealthy Clients are Thirsty for Better Advice

    New research uncovers the ultra-weathy's fast-growing demand for better, in-depth investment advice.
  7. Entrepreneurship

    Jim Cramer Success Story: Net Worth, Education & Top Quotes

    Learn about Jim Cramer the man and how he got to be successful. Understand his different levels of success and what he is doing in 2015.
  8. Taxes

    Explaining Double Taxation

    Double taxation refers to income taxes being imposed twice on the same source of earned income.
  9. Retirement

    Top Reasons Not to Roll Over Your 401(k) to an IRA

    Five cases in which keeping your plan in place – or employing another non-IRA strategy – is the better move.
  10. Taxes

    Top Tax Tips to Deduct Investment Management Fees

    Investment expenses can be deducted by those who meet three main criteria. Here's what they are and how they work.
RELATED TERMS
  1. Wealth Management

    A high-level professional service that combines financial/investment ...
  2. Enterprise Investment Scheme (EIS)

    A UK program that helps smaller, riskier companies to raise capital ...
  3. Guideline Premium And Corridor ...

    A test used to determine whether an insurance product can be ...
  4. Cash Value Accumulation Test (CVAT)

    A test method used to determine whether a financial product can ...
  5. Capital Growth

    The increase in value of an asset or investment over time. It ...
  6. Variable Annuitization

    An annuity option in which the amount of income payments received ...
RELATED FAQS
  1. How are yields taxed on a certificate of deposit (CD)?

    Certificates of deposit (CDs) are popular savings vehicles for investors who are seeking a steady return that is not tied ... Read Full Answer >>
  2. How are non-qualified variable annuities taxed?

    Non-qualified variable annuities are tax-deferred investment vehicles with a unique tax structure. After-tax money is deposited ... Read Full Answer >>
  3. How do I use the holding period return yield to evaluate my bond portfolio?

    The holding period return yield formula can be used to compare the yields of different bonds in your portfolio over a given ... Read Full Answer >>
  4. What is the relationship between current yield and yield to maturity (YTM)?

    Both the current yield and yield to maturity (YTM) formulas are methods of calculating the yield of a bond. However, these ... Read Full Answer >>
  5. How can I use the holding period return yield to determine whether or not I should ...

    Use the holding period return yield formula to determine whether the time is right to sell your bond. With this calculation, ... Read Full Answer >>
  6. How do you calculate a present value of annuity using Excel?

    Calculating the present value of an annuity using Microsoft Excel is fairly straightforward if you know the interest rate, ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!