The IRS classifies earned interest as taxable income, and that includes interest earnings from deposit accounts like savings, checking, and certificates of deposit—as well as welcome bonuses earned from opening new accounts.

“If you receive a bonus for opening a new checking account or credit card, expect a Form 1099-INT or possibly a Form 1099-MISC at tax time,” says Hannah Black, Senior Tax Research Analyst at the Tax Institute at H&R Block. “Even if you don’t get the form, you must report the bonus on your tax return, so keep good records of any bonuses you receive.”

Paying taxes is an unavoidable part of life, and they should be considered part of the cost of building your personal savings. The amount you’ll owe is directly tied to your tax bracket; The higher the bracket, the greater the percentage you’ll owe on interest income. 

Interest on savings accounts is taxable income

The IRS classifies the interest earned from deposit accounts as taxable income, and any consumer who earned $10 or more in interest in the past calendar year can expect to receive a 1099-INT from the institution for tax preparation purposes. 

This form should make its way to you by January 31 each year and will detail exactly how much interest was paid on the account and must be reported on your taxes. You should expect to pay taxes on interest earned from the following types of accounts:

• Interest-bearing checking accounts
• Welcome bonuses on checking or savings accounts
• Certificates of deposit (CDs)
• Money market accounts (MMAs)

Yep, those attractive welcome bonuses count as taxable income, too. Keep this in mind if you decide to take advantage of these opportunities. 

Paul Miller, CPA, founder of Miller and Company, recommends setting a portion of your earned interest and welcome bonuses aside throughout the year to help cover this part of your tax bill. If you end up owing less than you anticipated, add the funds into your emergency savings.

Keep good records: You won’t always receive a 1099-INT

Financial institutions are required by the IRS to send out Form 1099-INT to all customers who earn over $10 in interest. They are not required to send it to anyone who doesn’t reach this threshold. You are responsible for keeping up with any and all interest income on your accounts and reporting it to the IRS.

“Make sure to keep track of your monthly financial statements,” says Black. Bank accounts, investment accounts, credit cards, and mortgages will all have their own unique forms that you must report.

If you don’t receive a 1099-INT automatically, that doesn’t mean you’re off the hook. Try checking your year-end financial statements or calling your bank to confirm what you earned. Worst-case scenario, you can contact the IRS directly to find out what you may owe.

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Tax-advantaged savings alternatives

While bank deposit rates on savings accounts remain high for now, they aren’t guaranteed to stay that way—and you’ll still owe taxes on any interest you accrue over time. 

Miller advises that people can reduce their tax liabilities by choosing a different type of savings vehicle. This may mean putting your money into an account you can’t touch for a long time, so be conscientious about your investing choices and don’t deposit more than you can afford. 

Some types of accounts that offer tax advantages include:

• Roth IRAs: Consider saving money on which you’ve already paid taxes in a Roth IRA—if your total annual income is below certain thresholds. You may contribute up to $7,000 per year to the IRA accounts in your name, and you can purchase a wide range of investment assets with money in the accounts. You may withdraw contributions from a Roth IRA tax-free at any time, but you’ll have to wait for five years from the date of your first deposit to withdraw earnings tax free.
  
• 529 plans: If you are saving for college or other tuition expenses, consider a 529 plan. A child is named as beneficiary of the plan, contributions are typically invested in mutual funds, and earnings grow tax-free. Qualified withdrawals for education expenses are tax free—and if the beneficiary doesn’t want to spend the funds on education, the balance may be rolled over into a Roth IRA in their name (up to $7,000 per year).

The takeaway

While yields on deposit accounts are expected to decline—depending on changeable market interest rates, naturally—many high-yield savings accounts, CDs, and other bank accounts are still offering strong rates and attractive welcome bonuses. 

If you choose to take advantage of these offerings you can earn a decent return on your investment—just don’t forget to set aside some of it aside for next year’s tax bill.