In the United States, the Internal Revenue Service considers interest earned in a savings account to be taxable income. Taxpayers are required to submit a 1099-INT form to the IRS when they file their tax returns; this form details the amount of earned interest on accounts held during the prior year. Certain types of retirement accounts, such as individual retirement accounts, allow interest on savings to accrue tax-deferred.

More information on the taxation of interest received can be found in Topic 403 on Backup withholding information is discussed in Topic 307.

Interest Earned Through Investments

Savings accounts are not generally thought of as investment vehicles. However, the IRS considers any interest-bearing financial instrument to be an investment for tax purposes.

Interest, once accrued in your savings account, is subject to taxation during the same year that you receive it. What happens to the money after you've received it is inconsequential; it will be taxed the same way regardless of whether you keep it, transfer it to a new account or spend it.

Tax Rate on Interest Income

Interest from a savings account is taxed at the marginal rate. In other words, if your regular income tax bracket places you in a 35% bracket, then the interest on your savings account is taxed at that rate.

Balance on the Savings Account

Though the earned interest on the savings account is taxed, you will not have to pay taxes on the account's balance. If your savings account has $10,000 and earns 0.2% interest, you are only taxed on the extra $20 in interest that the bank credits to you.

The Advisor Insight

The financial institution that holds your savings account mails a form 1099-INT, showing interest earned in the previous year, in late January. You are only taxed on any interest earned in the account over a minimum of $10, although the IRS requires you to report all taxable interest in your income. If you accepted a cash incentive from the bank to open a new savings account, that bonus is also taxable and needs to be reported as well. If your taxes are not paid on the interest earned in your savings account, the IRS will enforce penalties and fees.

These rules only apply to traditional or online savings accounts. They are not to be confused with savings held in an IRA. The interest on those is tax-deferred: You pay taxes on it only when the funds are withdrawn.

Rebecca Dawson
Silber Bennett Financial
Los Angeles, CA