Interest income is taxed as ordinary income on your federal return, at the same rates that apply to your wages. For 2026, those rates run through seven brackets topping out at 37%.1Tax Foundation. 2026 Tax Brackets and Federal Income Tax Rates Interest does not qualify for the lower rates that apply to long-term capital gains or qualified dividends, so a dollar of interest is generally taxed more heavily than a dollar of investment profit held longer than a year. And you owe the tax whether or not a bank sends you paperwork.
The Rate You’ll Actually Pay
The Internal Revenue Code sweeps interest into the definition of gross income right alongside wages, business profits, and rents.2Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined It counts as unearned income because your money is doing the work, not your labor, but it still gets taxed at ordinary rates. Whatever marginal bracket your last dollar of wages sits in is the bracket your interest will sit in too.
The IRS is explicit that all taxable and tax-exempt interest must appear on your return whether or not you receive a Form 1099-INT.3Internal Revenue Service. Topic No. 403, Interest Received Interest from a personal loan you made to a friend, a foreign bank account, or a small credit union balance below the reporting threshold all belong on the return. Interest the IRS itself paid you on a late refund is taxable too, and it can surprise people who assume a government payment must be exempt.
The 3.8% Surtax for Higher Earners
On top of the regular brackets, high earners face an additional 3.8% Net Investment Income Tax on interest. The NIIT applies when your modified adjusted gross income exceeds $200,000 for single filers, $250,000 for married couples filing jointly, or $125,000 for married filing separately.4Internal Revenue Service. Topic No. 559, Net Investment Income Tax The tax is charged on the lesser of your net investment income or the amount by which your MAGI exceeds the threshold, so crossing the line by a small amount doesn’t surcharge your entire interest income.
Interest, dividends, capital gains, and rental income all count as net investment income for this calculation. Tax-exempt municipal bond interest is excluded.5Internal Revenue Service. Questions and Answers on the Net Investment Income Tax The thresholds are not indexed for inflation, so more taxpayers get pulled in each year as incomes rise.
Interest That Escapes Some or All Tax
Three categories get better treatment than a plain bank deposit.
Municipal bonds. Interest from bonds issued by state and local governments is generally excluded from federal gross income.6Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds The exclusion has carveouts for certain private activity and arbitrage bonds, but the vast majority of bonds bought through a standard brokerage qualify. The catch is at the state level: if you live in one state and buy a municipal bond issued in another, your home state may still tax the interest. Bonds issued by your own state or its localities are typically exempt from both federal and state tax. Your total tax-exempt interest shows up in Box 8 of Form 1099-INT.
U.S. Treasury securities. Interest from Treasury bills, notes, and bonds is fully taxable at the federal level but exempt from state and local income tax. That flip makes Treasuries especially attractive for investors in high-tax states, where the effective after-tax yield can beat a nominally higher-rate taxable alternative.
Education savings bonds. If you cash in Series EE or Series I savings bonds to pay for qualified higher education expenses, you may be able to exclude some or all of the interest from federal income tax. The bond must have been issued after 1989 to someone at least 24 years old at the time of purchase, and the proceeds must go toward tuition and fees at an eligible institution for you, your spouse, or a dependent. Contributions to a 529 plan or Coverdell education savings account also count as qualified expenses.7Office of the Law Revision Counsel. 26 USC 135 – Income From United States Savings Bonds Used to Pay Higher Education Tuition and Fees The exclusion phases out at higher incomes, with thresholds adjusted for inflation each year.
What Counts as Taxable Interest
Bank Accounts and CDs
Savings accounts, checking accounts, money market accounts, and high-yield online savings accounts all generate taxable interest. With rates on high-yield accounts often several percentage points above traditional banks, the interest can easily grow large enough to push you onto Schedule B.
Certificates of deposit work the same way but lock your money up for a fixed term. If you break a CD early, the financial institution typically charges a penalty, and that penalty appears in Box 2 of your 1099-INT.8Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID You can deduct the early withdrawal penalty as an adjustment to income on Schedule 1 of Form 1040, which lowers your adjusted gross income whether you itemize or not. The deduction applies even if the penalty exceeds the interest you earned on that CD.
Bonds and Original Issue Discount
Corporate bonds pay interest that’s fully taxable at both the federal and state level. Municipal and Treasury bonds carry the treatments described above. Each payer issues its own 1099-INT.
Some bonds are issued at a price below their face value, and the difference between the purchase price and the amount you receive at maturity is called original issue discount. Zero-coupon bonds are the classic example. Even though you don’t receive cash payments along the way, the IRS treats the annual increase in the bond’s value as taxable interest income you must report each year as it accrues.9Internal Revenue Service. Publication 1212, Guide to Original Issue Discount (OID) Instruments You’ll receive Form 1099-OID showing the amount to include. A de minimis exception exists: if total OID on a bond is less than one-quarter of 1% of the face value multiplied by the number of years to maturity, you can treat it as zero.
Private Loans
Interest you receive from a personal loan to a friend or family member is taxable income even though no bank is involved and no 1099 will be issued. The same goes for seller-financed mortgages, where you act as the lender and the buyer makes payments directly to you.
How to Report It on Your Return
Your total taxable interest goes on the “Taxable interest” line of Form 1040. If that total exceeds $1,500, you must also complete Schedule B, which lists each payer individually along with the amount received.10Internal Revenue Service. Instructions for Schedule B (Form 1040) Falling below $1,500 doesn’t exempt you from reporting; it just lets you skip the payer-by-payer breakdown.
The 1099-INT Boxes That Matter
Financial institutions must send you a Form 1099-INT if they paid you $10 or more in interest during the year.8Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Most arrive by late January. If you earned less than $10 from a particular account, you won’t get a form, but you still owe tax on the amount.
- Box 1 is the main total of taxable interest that you’ll transfer to your return.
- Box 2 shows early withdrawal penalties, which are deductible on Schedule 1.
- Box 3 reports interest from U.S. savings bonds and Treasury obligations, separated from Box 1 because the state-tax treatment differs.
- Box 4 shows federal income tax withheld under backup withholding, typically at 24%, which applies when you failed to provide a correct taxpayer identification number to the payer.11Internal Revenue Service. Backup Withholding
- Box 8 shows tax-exempt interest from municipal bonds. Report it on your return even though it isn’t taxed federally.
If a 1099-INT contains an error, contact the payer and request a corrected form. If you can’t get one before the filing deadline, file on time using the figures you believe are correct. If a corrected form arrives after you’ve filed and the numbers differ, file Form 1040-X to amend.12Internal Revenue Service. What to Do When a W-2 or Form 1099 Is Missing or Incorrect
Two Adjustments That Trip People Up
When you buy a bond between interest payment dates, you pay the seller for interest that has accrued since the last payment. The next interest payment you receive will include that accrued portion, and your 1099-INT will reflect the full amount. To avoid being taxed on money you effectively paid to the seller, report the full 1099 amount on Schedule B line 1, then subtract the accrued interest by entering “Accrued Interest” and the amount below your subtotal.10Internal Revenue Service. Instructions for Schedule B (Form 1040)
If you received a 1099-INT for interest that actually belongs to someone else, such as a joint account where a portion belongs to another person, you’re considered a nominee. Report the full amount from the 1099, then subtract the nominee portion by entering “Nominee Distribution” and the amount below the subtotal. You must also issue a 1099-INT to the actual owner, unless it’s your spouse, and file a copy with the IRS along with Form 1096.13Internal Revenue Service. 2025 Instructions for Schedule B (Form 1040)
The Timing Choice on Savings Bonds
Series EE and Series I bonds create a timing decision most other interest income doesn’t. You can defer reporting the interest until you cash the bond or it matures, or report the interest annually as it accrues even though you haven’t received any cash yet.14TreasuryDirect. Tax Information for EE and I Bonds Most people defer, which means a potentially large lump sum of taxable interest in the year they redeem. If you choose annual reporting, you won’t receive a 1099 each year; you’ll need to use TreasuryDirect or the Savings Bond Calculator to figure how much interest to include.
Foreign Accounts Add Filings on Top of the Tax
Interest earned in foreign bank accounts is taxable in the United States, and it triggers reporting obligations beyond your regular tax return. If the combined value of all 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) electronically with FinCEN, regardless of whether the accounts generated any income.15Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR) The statutory penalty for a non-willful failure to file starts at $10,000 per violation and may be adjusted for inflation.
Separately, the Foreign Account Tax Compliance Act requires you to report specified foreign financial assets on Form 8938, attached to your tax return, once you cross thresholds that vary by filing status and residence.16Internal Revenue Service. Summary of FATCA Reporting for U.S. Taxpayers FBAR and Form 8938 are separate filings with different thresholds and due dates. Having to file one doesn’t excuse you from the other, and many taxpayers with foreign accounts must file both.
How Mismatches Get Caught
The IRS matches every 1099-INT it receives against what you report. When the numbers don’t line up, you’ll typically receive a CP2000 notice proposing additional tax. These notices are automated, and the burden shifts to you to explain any discrepancy.
The common triggers are forgetting an account you rarely check, missing a 1099-INT that went to an old address, and failing to report interest below the $10 filing threshold where no 1099 was issued. If an understatement is large enough, the IRS can impose an accuracy-related penalty equal to 20% of the underpaid tax.17Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments The easiest defense is to pull your IRS wage and income transcript in the spring, see every 1099 filed under your Social Security number, and make sure your return accounts for each one.