Interest income is taxed by the federal government as ordinary income, at the same 10% to 37% brackets that apply to wages.1Internal Revenue Service. Federal Income Tax Rates and Brackets A handful of exceptions carve out municipal bond interest and certain savings bond interest, and a 3.8% surtax sits on top of the regular rates for higher earners. State treatment varies, and some federal debt gets a state-tax break that corporate bonds do not.
The Ordinary-Income Rule
The IRS treats interest as gross income, right alongside wages and business profits.2GovInfo. 26 USC 61 – Gross Income Defined Long-term capital gains and qualified dividends get preferential rates. Interest does not. Every dollar of taxable interest stacks on top of your other income and is taxed at whatever bracket it lands in.
That covers the everyday sources: savings accounts, money market accounts, certificates of deposit, corporate bonds, seller-financed notes, and peer-to-peer loans. U.S. Treasury bills, notes, and bonds also pay federally taxable interest, but federal law exempts that interest from state and local income tax.3Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation For someone in a high-tax state, that difference alone can matter more than the yield gap between Treasuries and comparable corporate bonds.
Series EE and Series I savings bonds work differently. You can defer reporting the interest until you cash the bond or it matures, which may be up to 30 years out, or you can elect to report it as it accrues each year.4TreasuryDirect. Tax Information for EE and I Bonds The annual-accrual choice sometimes makes sense for bonds held in a child’s name.
The 3.8% Net Investment Income Tax
High earners face an added layer. The Net Investment Income Tax applies 3.8% on top of ordinary rates, and interest is one of the categories counted.5Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax It kicks in when modified adjusted gross income tops $200,000 for single filers, $250,000 for married couples filing jointly, or $125,000 for married filing separately.6Internal Revenue Service. Topic No. 559, Net Investment Income Tax The 3.8% is charged on the smaller of your net investment income or the amount your MAGI exceeds the threshold. Someone with $220,000 in MAGI and $30,000 in net investment income owes the surtax on $20,000. These thresholds are not adjusted for inflation, so more households cross them every year.
Interest That Escapes Federal Tax
Municipal Bonds
Interest from bonds issued by state and local governments is generally excluded from federal income tax.7Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds Private activity bonds that fail certain requirements and arbitrage bonds lose the exemption, but standard bonds from cities, counties, and state agencies qualify. You still have to report the tax-exempt interest on line 2a of Form 1040 as an informational disclosure.8Internal Revenue Service. 2025 Instructions for Schedule B (Form 1040) Reporting it does not make it taxable; the IRS uses the figure for eligibility calculations elsewhere on the return. At the state level, interest from your own state’s bonds is often exempt too, while another state’s bonds are typically taxable on your state return.
Savings Bonds Used for Education
Interest from Series EE and I savings bonds can be entirely tax-free if you spend the proceeds on qualified higher education expenses, including tuition, required fees at an eligible institution, or contributions to a 529 plan or Coverdell ESA.9Office of the Law Revision Counsel. 26 USC 135 – Income From United States Savings Bonds Used to Pay Higher Education Tuition and Fees Room and board do not count. The bond must have been issued after 1989 to someone at least 24 years old at the time. You claim the exclusion on Form 8815.
The benefit phases out at higher incomes. For 2025, the exclusion begins to shrink at $99,500 of modified AGI for single filers and $149,250 for joint filers, and disappears entirely at $114,500 and $179,250 respectively.10Internal Revenue Service. Publication 970 (2025), Tax Benefits for Education The thresholds adjust for inflation each year.
Reporting What You Earn
The 1099-INT and the $10 Threshold
Any bank, credit union, or other payer that pays you $10 or more in interest during the year must send you a Form 1099-INT by January 31.11Internal Revenue Service. About Form 1099-INT, Interest Income The $10 figure is a reporting trigger for the payer, not a floor for taxability. You owe tax on all taxable interest regardless of the amount. A savings account that earned $6 goes on the return even without a form.12Internal Revenue Service. Topic No. 403, Interest Received
Schedule B at $1,500
When your total taxable interest tops $1,500 for the year, you must file Schedule B with your Form 1040, listing each payer and the amount received.13Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends Below that, you enter the total on line 2b of the 1040 without the extra form.
When Interest Counts as Received
Interest becomes taxable when it’s credited to your account, not when you withdraw it. Under the constructive receipt rule, income counts as received in the year it was made available to you without substantial restrictions.14eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income If a bank credits $200 in December, that’s this year’s income even if you don’t touch it until March. This catches people off guard when a large CD matures late in the year; the interest is taxable that year whether or not you roll it into a new CD.
Original Issue Discount
Some bonds are issued below face value. A bond with a $1,000 face value might sell for $950, and the $50 gap is original issue discount. The IRS treats OID as interest that accrues over the life of the bond, so you include it in income each year as it accrues even though the cash arrives only at maturity or sale.15Internal Revenue Service. Publication 1212 (12/2025), Guide to Original Issue Discount (OID) Instruments Form 1099-OID follows if the annual amount is $10 or more.
Backup Withholding
If you don’t give the payer a correct taxpayer identification number, the payer must withhold 24% of your interest and remit it to the IRS.16Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide This is a prepayment credited against your final tax bill, not an added tax. Submitting a correct W-9 avoids it.
Interest Earned by a Child
Interest a child earns runs through a different set of rules known as the kiddie tax. For 2026, the first $1,350 of a child’s unearned income is offset by the standard deduction, the next $1,350 is taxed at the child’s own rate, and anything above $2,700 is taxed at the parent’s marginal rate.17IRS. Rev. Proc. 2025-32 It applies to children under 19, or under 24 if full-time students, with unearned income above those thresholds.
If a child’s only income is interest and dividends totaling more than $1,350 but less than $13,500, parents can elect to report it on their own return using Form 8814 instead of filing a separate return for the child.17IRS. Rev. Proc. 2025-32 The election saves paperwork but sometimes produces a slightly higher tax bill because the child’s income sits on top of the parents’.
Foreign Accounts
Interest earned in foreign bank accounts is taxable in the United States, and the reporting obligations run heavier than for domestic accounts. If your foreign financial accounts together exceed $10,000 at any point during the year, you must file a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114 by April 15, with an automatic extension to October 15.18Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR) The FBAR goes to FinCEN, not the IRS, and is separate from your tax return.
FATCA adds a second layer. Single filers whose specified foreign financial assets exceed $50,000 on the last day of the tax year, or $75,000 at any point during the year, must also file Form 8938 with the tax return. Joint filers get higher thresholds of $100,000 on the last day or more at any point.19Internal Revenue Service. About Form 8938, Statement of Specified Foreign Financial Assets
Penalties bite hard. Failure to file Form 8938 carries a $10,000 initial penalty, plus another $10,000 for each 30-day period the failure continues after the IRS mails notice, up to $50,000.20Internal Revenue Service. IRM 20.1.9 International Penalties Foreign financial institutions now report account information to the IRS under FATCA agreements, so unreported foreign interest tends to surface.
Penalties for Underreporting
The workhorse penalty is the accuracy-related penalty at 20% of the tax underpaid, applied when the shortfall stems from negligence or a substantial understatement of income.21Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments The IRS also charges interest on unpaid tax from the original filing deadline until you pay, at a rate that fluctuates quarterly.22Office of the Law Revision Counsel. 26 USC 6601 – Interest on Underpayment, Nonpayment, or Extensions of Time for Payment of Tax
Intentional underreporting is a different matter. The civil fraud penalty is 75% of the underpayment attributable to fraud, and willful violations can trigger criminal investigation.23Internal Revenue Service. 9.5.13 Civil Considerations These outcomes are rare for taxpayers who make honest mistakes, but they explain why tracking small interest payments from accounts you’ve forgotten about is worth the effort.