Interest Income (Taxable & Tax-Exempt Interest)
Most interest that you receive or that’s credited to an account that you can withdraw without penalty is taxable income in the year it becomes available to you.
The new tax law didn’t change the treatment of taxable or tax-exempt interest income.
Most interest received by you or credited to your account that you can withdraw without penalty is income.
Taxable interest includes: interest on bank accounts, money market accounts, certificates of deposit, corporate bonds, and deposited insurance dividends. Taxable interest also includes interest income from Treasury bills, notes, and bonds.
Some interest received by you isn’t counted as income for tax purposes. Tax-exempt interest is commonly earned from qualifying municipal and state bonds, which are issued to finance public improvements.
Other less common sources of tax-exempt interest income include interest on insurance dividends left on deposit with the U.S. Department of Veteran Affairs, and interest redeemed from Series EE and Series I bonds issued after 1989 when used to pay for qualified higher educational expenses during the year. See IRS Publication 970 – Educational Savings Bond Program.
Each payor of interest should’ve sent you an IRS Form 1099-INT, Interest Income or IRS Form 1099-OID, Original Issue Discount, which will indicate your total taxable interest income.
If you earn more than $1,500 in interest income, you must fill in and attach an IRS Form Schedule B, Interest and Ordinary Dividends.
For other than very large taxpayers, the new tax law didn’t change the treatment of taxable or tax-exempt interest income.
How will this affect me?
Shirley opens a savings account with Money Bank and deposits $10,000. Money Bank provides its customers with an annual percentage yield (APY) of 1.5 percent.
At the end of the year, Shirley receives a check for $150 from Money Bank. The $150 is taxable interest income to Shirley and should be reported on line 8a of Shirley’s Form 1040 tax return.
The city of Birmingham issues qualifying tax-exempt bonds to generate revenue to pay for new roads. Shirley, a resident of Birmingham, purchases five bonds for $50,000. The bonds have a coupon rate of 4.8 percent and mature in three years.
At the end of the first year, Shirley is paid $2,400 of tax-exempt interest, and it is reported in Box 8 on Form 1099-INT, Interest Income. Shirley must declare this as tax-exempt interest on Line 8b of her Form 1040 tax return, but she won’t be taxed on this income.