Interest income or investment income is income, plain and simple, as far as the U.S. government is concerned. That means, in most cases, you must report interest income when you file your taxes.
Savings accounts, certificates of deposit (CDs), and more … the typical investor may receive interest income from a variety of sources, in amounts ranging from a few bucks to perhaps thousands of dollars.
With the 2018 tax season upon us, it’s critical to have a firm grip on your taxable interest so you can provide a full accounting to the Internal Revenue Service (IRS). A few need-to-knows:
What Is Taxable Interest Income?
Income from interest-bearing financial instruments is typically taxable as ordinary income, as is income from personal loans. Most interest-bearing financial instruments and accounts generate taxable interest (with the exception of tax-exempt bonds issued by states and municipalities).
How About Some Examples of Taxable Interest?
In addition to CDs and savings accounts, taxable interest applies in several other areas. Money market accounts, corporate bonds, and deposited insurance dividends also generate taxable interest, as do certain “distributions,” commonly referred to as dividends.
Sources of dividends include share accounts in cooperative banks, credit unions, domestic building and loan associations, domestic federal savings and loan associations, and mutual savings banks, according to the IRS. Interest income from Treasury bills, notes, and bonds is subject to federal income tax, but is exempt from all state and local income taxes.
There’s also “other” interest, which is paid to you by a business and should be reported on Form 1099-INT (more on that below) if it’s $600 or more (for example, interest received from damages or delayed death benefits).
How Is Taxable Interest Taxed?
Regular taxable interest is taxed as ordinary income, similar to a distribution from an individual retirement account (IRA) or other retirement plan. This means that interest is taxed at the taxpayer's marginal tax rate.
For example, for a taxpayer in the 28% tax bracket, interest income is taxed at that rate. This applies both for interest that’s fully taxable at all levels, and for interest taxable only at the federal level.
What About the Documents?
Keep an eye on the mailboxes. Payers of investment income must issue a Form 1099-INT to all recipients showing the amount and type of interest paid during the year. If you're a TD Ameritrade customer and you've signed up for E-Delivery of documents, you'll receive a message via your personal email once your documents are ready to be viewed. Otherwise, look to your snail mailbox for physical delivery of documents.
You should receive Form 1099-INT, or Form 1099-OID, reporting payments of interest of $10 or more (these forms may arrive in your mailbox as part of a composite statement from a broker). For more, refer to "Your Guided Tour Through the Consolidated 1099 Tax Form."
Even if you don’t receive a 1099-INT or 1099-OID, the IRS requires that you report all taxable and tax-exempt interest on your federal income tax return (and you must give the payer of interest income your correct taxpayer identification number; otherwise, you may be subject to a penalty and backup withholding).
Any Exceptions to These Rules?
The IRS offers a few examples of “nontaxable” or “excludable” interest.
Interest redeemed from Series EE and Series I U.S. Savings Bonds issued after 1989 may be excluded from income when used to pay for qualified higher educational expenses during the year—if you meet the other requirements for the Educational Savings Bond Program.
Interest on some bonds that’s used to finance government operations and is issued by a state, the District of Columbia, or a U.S. possession is reportable, but not taxable, at the federal level.
Also, interest on insurance dividends left on deposit with the U.S. Department of Veterans Affairs is nontaxable interest and not reportable. Consult a tax professional for additional guidance.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
A Less Taxing Tax Season?
Preparedness can be the key to navigating tax season. The TD Ameritrade tax page contains a list of key dates, deadlines, and forms.