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The Internal Revenue Service considers all of your income from all sources to be taxable income unless it is specifically exempted from taxation by law. That includes income from working, such as wages, salaries, commissions and tips; income from investments, such as capital gains and dividends; and income from savings, such as interest on your bank certificates of deposit and savings accounts.
Interest is income that is generated from the loan of money. When you take out a mortgage or car loan, you expect to pay back more than you borrowed. That extra amount is interest, and it is the cost you incur for using someone else's money for a period. You might not think of your savings account as a loan, but it is. When you deposit money into your savings account, you are loaning your money to the bank for a set rate of interest and usually with the stipulation that you can take your money back anytime you wish. The bank uses the money that you have on deposit to make loans to other consumers or businesses. The bank makes money by lending the money at a higher percentage rate than it pays you.
The interest the bank pays you on money in your savings account is taxable income, according to the Internal Revenue Service. Some types of savings institutions might refer to interest by different names. For example, you might have a savings account with a credit union, and the credit union might refer to the money in your account as shares and the interest it pays as dividends. The IRS considers such income to be interest, regardless of the name it is given.
Any financial institution that pays interest on your savings account should provide you with a Form 1099-INT detailing the amount of interest it paid you during the tax year. You are responsible for reporting all interest you received during the tax year when you file your federal income tax return, regardless of the amount and regardless of whether you received a Form 1099-INT. If the savings institution gave you a gift, such as a toaster, for opening a savings account, the IRS considers that gift to be taxable interest. Report the total amount of your interest income from all sources on Line 8, Form 1040.
You might agree to leave your savings money on deposit for a specified period in exchange for a higher interest rate. The bank might assess an interest penalty if you withdraw your funds before the agreed upon date. When you file your federal income tax return, you must report the entire amount of interest you were paid without deducting the amount of the penalty. You can reduce the amount of your taxable income by including the penalty amount on Line 30, Form 1040, as an adjustment to income.
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