Earning interest on your savings may seem like free money. And in a sense it is, although it usually comes with a tax bill.
If you keep cash in a money market account (MMA), the interest earned on your balance is generally considered taxable income, even if you never withdraw it. Understanding how interest on money market accounts is taxed and how to report your earnings can help you avoid surprises during tax season and comply with IRS rules.
Do you pay taxes on money market accounts?
Only a portion of the money in your MMA is subject to taxes. The principal balance, or money you personally deposited, is not subject to taxes because you already paid income taxes on that money before adding it to your account.
However, the interest you earn on your balance is considered taxable income. You must pay federal taxes on your earnings each year. And depending on where you live, you may also have to pay state taxes.
If you earn $10 or more in interest in a calendar year, your bank or credit union must send you a Form 1099-INT, Interest Income, which details the total amount of interest income earned that year. You must report that interest on your taxes, whether you have withdrawn the funds or not.
But what if you didn’t receive a 1099-INT? Unfortunately, you are still expected to report all interest income when you file your taxes.
Read more: Top 10 Money Market Accounts and Rates Available Today
How to Report Interest on a Money Market Account
You can usually view your year-to-date (YTD) interest earnings by logging into your online banking account or reviewing your most recent bank statement.
However, as mentioned, you should receive a Form 1099-INT if you earned $10 or more in interest during the tax year. In some cases, you may need to download the form from your online account or request it directly from your bank. But remember: Even if you don’t receive a 1099-INT, you’re still responsible for reporting any taxable interest earned to the IRS.
When you file your taxes, report the amount shown in Box 1 of Form 1099-INT on the taxable interest line of your tax return. If you earned any of the tax-exempt interest listed in Box 8, report that amount on the tax-exempt interest line. You should also include any federal income tax withheld shown in Box 4. Once you have finished filing your return, save your 1099-INT with the rest of your tax documents to save in case of a future IRS audit.
How much tax will you owe?
Interest earned from an MMA is generally taxed as ordinary income, meaning it is taxed at the same federal income tax rate as your wages or salaries. The exact amount you’ll owe depends on your total taxable income and your federal tax bracket, as well as whether your state taxes interest income.
You can estimate how much you should multiply the interest earned by your marginal tax rate. Keep in mind that earning interest could also slightly increase your total taxable income, which may affect eligibility for certain tax credits or deductions in some cases. If you are unsure how your interest earnings may affect your taxes, consider consulting a tax professional.