One of the questions that many have when it comes to taxes is whether or not it is required to pay taxes on deposit account earnings. The short answer is yes. If you earn interest on a deposit account, you normally have to pay taxes. However, it helps to know a little more about the policies surrounding taxes and deposit account interest income.
Reporting All Income to the IRS
When you file your taxes, the IRS expects you to report all your income, no matter how small. This includes income from any side businesses that you may have, as well as income from interest and from dividends. It is important to note that you are supposed to report income even if you don’t receive a 1099. Just because you didn’t get a copy of a 1099 doesn’t mean that the IRS didn’t receive one. On top of that, if the IRS decides to take a closer look at your tax return paperwork, an agent might find a bank account that shows that you earned more than you reported. You would have to pay a penalty, interest and, of course, the amount that you owe. This can get pricey. Plus, if the agent suspects outright tax fraud rather than an innocent mistake, it can get even uglier – and more expensive.
Your interest income will be taxed at your marginal tax rate. This is the rate of the highest tax bracket you fall into. (Your entire income is not taxed at the same rate. Each level of income is taxed at the bracket it falls into. A portion of your income is taxed at 10%, a portion at 15%, a portion at 25% and so on, up to the highest tax bracket you are in.) Your interest earnings will be added to your earned income and other income as you figure your adjusted gross income.
Interest on Your Savings Account
You will need to report the interest earnings from your savings accounts. This also includes reporting interest earnings from money market accounts and from interest bearing checking accounts. Most of the time, you can find information about the interest you earned on the 1099-INT that your financial institution should send you. You can also ask your bank for this information, or look at your bank statement for the last month of the year for information on interest that you have earned for the year. If you are a member of a credit union, any dividends you receive as a member will be counted as bank interest.
When reporting income from interest, you can do so on the front side of your Form 1040A, or on your Form 1040EZ if you have earned less than $1,500 in interest. If your interest earnings amount to more than $1,500, you will have to file a Schedule B along with your tax return. If you end up having to file a Schedule B, it will make you ineligible to file a Form 1040EZ.
If you also earn money from dividends, exceeding the amount of $1,500, you are probably familiar with Schedule B, since you use it for both dividends and for interest earnings. It is worth noting, though, that your earnings are clearly separated by category. You do not add your dividends and your interest income together to determine whether or not to file a Schedule B. If you earn $1,300 in interest income, and $1,000 in dividends, you will not have to file a Schedule B. You only have to file the Schedule B when one of the totals reaches $1,500.
Interest from Your Certificates of Deposit
One of the most important things to remember is that you owe taxes on interest income earned on a CD. This is true in most cases – even if you did not receive a check for the interest. You will probably receive a 1099-INT detailing the interest your CD account earned for the year, and you are generally expected to pay taxes on the income for the year that you earned it. So, even if the bank didn’t sent you a check for the interest (some just add it to the CD), you still have to pay income taxes on the interest.
The main exception (and there are others) to paying income tax on your CD interest earnings is the IRA CD. Because a traditional IRA is a tax-deferred account, you do not usually have to pay taxes until you actually withdraw money from your CD account. This is one of the reasons that some prefer to open an IRA CD, instead of other CD products.
Your interest earnings from a CD may be offset by penalties that you pay for early withdrawal. As you know, taking money from your CD account before it expires will result in a penalty. This penalty can provide you with a tax break. Basically, you end up subtracting the amount of the penalty from the amount of interest that you earned to get your effective interest income from the CD. You would report your CD penalties on your tax form, and it would offset some of the earnings from interest that you report.
The IRS expects that you will report your interest earnings. In most cases, you are likely to receive a 1099-INT describing your interest income. Even if you don’t receive this paperwork, though, you should still report your earnings. If you have a question about your taxes, and what should be reported on them, it is a good idea to consult a tax professional who can help you navigate the rules.