Interest income is taxed as ordinary income at your marginal federal tax rate, which ranges from 10% to 37% in 2026. That puts interest in the same tax lane as wages and retirement distributions, without the preferential rates that long-term capital gains and qualified dividends enjoy. Higher earners can owe an additional 3.8% surtax on top, and a handful of interest sources — municipal bonds, U.S. Treasuries, and certain savings bonds used for education — get partial or full exemptions.
What Interest Is Taxable
Federal law defines gross income to include interest from almost any source.1Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined The implementing regulation names savings accounts, bank deposits, promissory notes, mortgages, corporate bonds, and even interest on tax refunds.2eCFR. 26 CFR 1.61-7 – Interest Money market accounts, certificates of deposit, and insurance policy dividends left with the insurer to accumulate also qualify.3GAO. Tax Policy: Tax Treatment of Life Insurance and Annuity Accrued Interest If you lend money to a friend or relative and charge interest, those payments are taxable to you even though no bank is involved and no tax form arrives in the mail.
One rule catches people off guard. Interest is taxable in the year it’s credited to your account, whether or not you withdraw it. Under the constructive receipt doctrine, income you could access counts as received.4eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income A December CD interest posting means tax for that year, even if the CD doesn’t mature until later.
Loans to Family or Friends
If you lend money at zero interest or well below market rates, the IRS may impute interest to you as if you had actually collected it. Under Section 7872, when the rate falls below the applicable federal rate, the “missing” interest is treated as paid, and the lender owes tax on it.5Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
A de minimis exception protects small gift loans between individuals: the imputed interest rules don’t apply if the total outstanding balance stays at or below $10,000, unless the borrower uses the funds to buy income-producing assets. For loans between $10,000 and $100,000, imputed interest is capped at the borrower’s net investment income for the year, and if that investment income is $1,000 or less, it’s treated as zero.5Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
The 2026 Rates That Apply
Every dollar of taxable interest stacks on top of your other ordinary income and is taxed at your marginal bracket. For 2026, the federal brackets for single filers are:6Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
- 10% on taxable income up to $12,400
- 12% from $12,401 to $50,400
- 22% from $50,401 to $105,700
- 24% from $105,701 to $201,775
- 32% from $201,776 to $256,225
- 35% from $256,226 to $640,600
- 37% on taxable income above $640,600
For married couples filing jointly, each threshold roughly doubles: the 12% bracket runs up to $100,800, the 22% bracket to $211,400, and the 37% rate begins above $768,700. The 2026 standard deduction is $16,100 for single filers and $32,200 for joint filers, so if your total income including interest stays below those levels, no federal income tax is due.6Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
The 3.8% Surtax on Investment Income
Higher earners owe an additional 3.8% net investment income tax on interest and other investment income. It applies to the lesser of your net investment income or the amount by which modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers.7Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax These thresholds aren’t indexed for inflation, so more taxpayers cross them each year. Someone in the top bracket with meaningful interest income can face an effective federal rate of 40.8% on that interest.
Interest That’s Exempt or Taxed Differently
Municipal Bonds
Interest on bonds issued by state and local governments is generally excluded from federal gross income.8Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds You still report the interest on your federal return, but no tax is due on it. The exclusion makes municipal bonds most attractive to people in higher brackets, where the federal tax savings can outweigh the lower stated yields.
Two limits are worth knowing. Interest from certain private activity municipal bonds — those funding projects that benefit private entities rather than the general public — counts as a preference item for the Alternative Minimum Tax.9Internal Revenue Service. TEB Phase II – Lesson 4 General Rules for Private Activity Bonds For 2026, the AMT exemption is $90,100 for single filers and $140,200 for joint filers.6Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 And most states tax interest on municipal bonds issued by other states, so out-of-state munis may not be fully tax-free where you live.
U.S. Treasuries
Interest on Treasury bills, notes, bonds, TIPS, and floating-rate notes is taxable at the federal level but exempt from state and local income taxes.10TreasuryDirect. Tax Forms and Tax Withholding For residents of high-tax states, that exemption can meaningfully lift the after-tax yield compared with a CD or corporate bond paying the same headline rate.
Savings Bonds Used for Education
Series EE and I savings bonds issued after 1989 to someone who was at least 24 at purchase can qualify for full federal exclusion when the redemption proceeds pay qualified higher education expenses like tuition and fees. Room and board don’t count.11Office of the Law Revision Counsel. 26 USC 135 – Income From United States Savings Bonds Used to Pay Higher Education Tuition and Fees
The break phases out at higher incomes. For 2026, the phase-out begins at $101,800 of modified adjusted gross income for single filers ($152,650 joint) and ends at $116,800 ($182,650 joint). Even outside the education exclusion, savings bond holders can defer reporting interest until redemption or final maturity, which gives you some control over when the income lands.
How You Report Interest on Your Return
Banks, brokerages, and other payers send you Form 1099-INT for any account that earned at least $10 in interest during the year.12Internal Revenue Service. About Form 1099-INT, Interest Income Box 1 shows ordinary taxable interest; Box 3 separately reports interest on U.S. savings bonds and Treasury obligations, which helps at state-tax time.13Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
Not getting a 1099-INT doesn’t mean interest is tax-free. If an account earned less than $10, no form is required, but the interest is still taxable.12Internal Revenue Service. About Form 1099-INT, Interest Income The same is true of interest paid to you on a personal loan — no institution generates a form, so tracking it is on you.
If your total taxable interest for the year exceeds $1,500, complete Schedule B and list each payer with the amount received; the total flows to Form 1040. At $1,500 or less, you can enter the total directly on Form 1040 and skip the schedule.14Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends
Deducting an Early Withdrawal Penalty
Cash out a CD early and the bank charges a penalty, then reports both the interest and the penalty on your 1099-INT. The penalty is deductible as an adjustment to income on Schedule 1 of Form 1040, reducing your adjusted gross income whether you itemize or not. It’s easy to miss because the interest figure draws the eye first.
Foreign Accounts: Extra Filings, Same Tax
Interest earned in foreign bank accounts is fully taxable on your U.S. return the same as domestic interest. The complication is separate reporting. If the combined value of your foreign financial accounts exceeds $10,000 at any point during the year, you must file a Report of Foreign Bank and Financial Accounts (FBAR) with FinCEN.15Financial Crimes Enforcement Network. Reporting Maximum Account Value It’s due April 15 with an automatic extension to October 15.16Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR)
Form 8938 is a separate obligation under FATCA, filed with your tax return. For single filers living in the U.S., it applies if foreign financial assets exceed $50,000 on the last day of the year or $75,000 at any point during the year; for joint filers, the thresholds are $100,000 and $150,000.17Internal Revenue Service. Do I Need to File Form 8938, Statement of Specified Foreign Financial Assets Meeting one filing doesn’t satisfy the other.
What Happens If You Leave Interest Off
The IRS gets a copy of every 1099-INT your bank files, and automated matching flags omissions quickly. An accuracy-related penalty of 20% can apply to the underpayment portion caused by negligence, which includes failing to report income shown on information returns.18Internal Revenue Service. Accuracy-Related Penalty The IRS also charges interest on the unpaid tax from the original due date until you pay in full, at the federal short-term rate plus 3%, compounded daily.19Internal Revenue Service. Topic No. 653, IRS Notices and Bills, Penalties and Interest Charges Reporting every dollar of interest, including amounts under $10 that never generated a form, is the cheapest way to keep those extra costs off the bill.