What Is the Tax Rate on Interest Income?

Taxable interest is ordinary income, not capital gains.
Image Credit: AndreyPopov/iStock/Getty Images

Most interest income is taxable in the United States and is classified as unearned income for the purposes of tax reporting. Most taxpayers simply enter the interest income on the appropriate line of their tax form -- but if you make more than $1,500, you are required to submit Form 1040 Schedule B to document your interest income. The tax rate charged on interest income varies depending on the total adjusted gross income of the individual taxpayer.

Tax Rates

Interest income is added to your adjusted gross income on your tax returns. The amount of interest income for the year increases your taxable income, so it is taxed at your marginal tax rate. The marginal tax rate is the highest tax bracket rate your income falls under. For example, in 2014 the lowest tax bracket for a single taxpayer is $9,075. You pay 10 percent of your taxable income if it is not greater than this bracket amount. The next bracket is $36,900 -- you pay $907.50 plus 15 percent of your income above $9,075.The remaining bracket amounts and rates are $89,350 (25 percent), $188,350 (28 percent), $405,100 (33 percent), $406,750 (35 percent), and any amount above $406,750 (39.6 percent). Different brackets apply to married couples.

How to Report Interest Income

Interest income includes both interest that is paid to you and interest that has accrued on your accounts. For example, if you have a certificate of deposit that accrues interest over a five-year period, but only pays out the interest at the end of the term, you are still responsible for paying taxes on that interest after the first year because the interest has accrued. Interest income is reported on your tax returns.

Additional Forms

If your income from interest is greater than $1,500, you cannot use Form 1040EZ to file your taxes, because you must file a Schedule B. Schedule B details where all of your interest income came from. If you withdrew money early from an account like a CD and lost interest payments because of it, you must file a Schedule B and use Form 1040.

Tax-Deferred Interest Income

Usually, you do not have to inform the government of accrued interest on Series EE and Series I U.S. Savings Bonds until you cash them in. However, since interest is added onto your income for the year and therefore is taxed at your marginal rate, if you think you will be in a higher bracket when you cash in the bonds, it may be better to pay taxes on the accrued interest when you are still in the lower tax bracket.

Non-Taxable Interest Income

U.S. Savings Bonds may generate tax-free interest if they were issued after 1989 and the interest was used to pay qualified higher-education expenses in the year you cashed in the bond. Municipal bonds are usually tax-free as long as they are used to finance essential functions of the state or local government that issues them. Although not taxable, you must report non-taxable interest income on your federal returns.

references & resources