Hey, big saver: If you have a bunch of cash sitting in your checking account and are wondering if you have to pay taxes on your interest income …
You should be worrying, but only because you’re keeping thousands of dollars in a checking account that earns just 0.01% APY in interest, instead of putting it into an account where it can grow!
Let’s say you have $10,000 in your bank account. At this rate, at the end of the year, you will have earned a whopping $1 in interest, assuming you keep a minimum balance of $10,000 (unlikely since this is a checking account we’re talking about) and the bank compounds monthly.
For this reason, you most likely won’t have much from this account to report on your income tax return.
Do you have to report taxes from a checking account?
The Internal Revenue Service requires taxpayers to report interest from all taxable accounts — and this means checking accounts, even if they only generate a few dollars in interest each year. Unfortunately, checking accounts aren’t tax-exempt; all interest should be reported as ordinary income.
This may come as a surprise if you haven’t been getting tax forms from your bank. But financial institutions only have to send form 1099-INT to customers who generate more than $10 in interest.
Just because your bank doesn’t send a 1099 form doesn’t mean you can avoid sending the payment. Unfortunately, the bank will send a 1099 to the IRS — meaning you could be on the hook for interest and penalties, turning a small amount of taxes into a larger sum.
Reporting savings interest to the IRS
Tracking and reporting savings interest to the IRS becomes even more important with a high-yield savings account (HYSA), which is most likely going to generate a lot more money in interest.
For example, if you put $10,000 into an HYSA with a 0.40% APY and didn’t make any monthly contributions, you’d accumulate $40 in interest, assuming the variable APY didn’t change. If you put more in — say $25,000 — you would rack up $100 in interest.
While this won’t bump you up into the next tax bracket, it’s still better than what you’d get in a standard checking account.
How to pay taxes on your checking account
The good news is that paying taxes on a checking account isn’t difficult. And for most people, the amount of taxes that have to be paid from a standard low-interest checking account is negligible.
Here’s a breakdown of how to pay taxes on your checking account.
1. Wait for the bank to send you a 1099
Wait until tax season rolls around and see if your bank sends you a 1099 form. The bank most likely is not going to send a form unless you have a good chunk of cash in your checking account.
You can request a form by contacting the bank or viewing your annual statement from the previous year online.
If the bank doesn’t send you a 1099, check your statement to determine how much you collected in interest from January 1 through December 31 of that year. It’s also a good idea to call the bank and verify that the numbers are accurate. You may also want to request a notice writing, just to be on the safe side.
2. Fill out form 1099-INT
If the bank doesn’t send you a 1099 tax form, download one from the internet and fill out the information.
Or, if you use someone for tax preparation, simply provide the information so that they can factor the information into your estimates.
3. Pay the balance
Tips for managing taxes
Nobody likes paying taxes. However, there are some things that you can do to take the sting out of forking money over to Uncle Sam every year.
Set money aside for taxes
If you only have a full-time job, then you don’t have to worry about taking money out for taxes. However, you can adjust how much you withhold to make life a bit easier for yourself. Talk to your HR department about this if you need to change your withholdings.
If you are self-employed with a side hustle or full-time gig, you’ll need to be extra careful to withhold money on your own.
For example, suppose you make wool socks and sell them on sites like Etsy and eBay and bring in $5,000. You’ll be responsible for paying the self-employment tax rate of 15.3% (12.4% for Social Security and 2.9% for Medicare).
In addition, you’ll also have to pay regular income tax on your earnings.
Set money aside as you make it to avoid winding up with a large tax bill that you can’t pay at the end of the year.
While self-employed individuals might have a higher income tax rate, they also have the ability to generate more money than salaried individuals. It’s a trade-off that many consider worthwhile.
Get a tax advisor
Even if you are savvy with money and know your way around taxes, it’s a good idea to hire a tax advisor or use a robust tax software. You can never be too safe when it comes to taxes, and the last thing you want is to get hit with hefty interest payments because you did something wrong.
This is particularly important as you start making more money. It’s critical to find someone who can reduce your taxes and help you identify various strategies that work to your advantage.
Sure, you might have to pay a few hundred dollars. But it’s worth it to have peace of mind.
At the same time, it’s also easier and could potentially save you thousands of dollars in taxes.
Look for special deductions
Make sure you’re claiming the most you possibly can when completing your taxes. There’s nothing worse than paying more than you should.
For example, if you work from home full-time, you may be able to claim a home office deduction or write off certain communications expenses if you qualify.
Either way, you need to explore the various options to see how much you can potentially save.
Better ways to earn interest
If you truly have a stash of money sitting in your bank account doing nothing for you, this should be a wake-up call about checking account interest rates. The fact is that if you’re storing enough money in your checking account to even be disappointed about a low interest rate, you’re probably doing something wrong.
Here are some alternatives to start producing more interest from your hard-earned money.
Money market accounts
Money market accounts are like traditional checking and savings accounts. For example, they come with debit cards and ATM access.
The main difference between money market and checking accounts is that they generate interest from money markets.
And as a result, they deliver higher returns to customers. Most money market accounts are in line with HYSAs in terms of interest rates.
Certificates of deposit (CDs)
CDs are a type of deposit account that typically come with much higher interest rates, in the 0.40% APY to 0.50% APY range.
The tradeoff with a CD is that you can’t touch your money for the duration of the term that you sign up for — whether that’s one month or 10 years.
So ultimately, from a money-making point of view, CDs are better than checking accounts because you can earn more money in interest. Plus, since your money will be locked up, you won’t be able to spend it, leading to greater returns.
A better way to generate interest from your money is to invest in the stock market, using individual stocks, index funds, exchange-traded funds (ETFs), mutual funds, and real estate investment trusts (REITs).
The easiest way to do this is to open a brokerage account through a provider like Fidelity. Just keep in mind that you’ll have to pay interest on any capital gains and dividends that you bring in. And if you buy foreign stocks, you might have to pay foreign transaction fees.
You can also generate strong interest in addition to tax benefits by putting your money into a retirement account like a traditional IRA or 401(k) or into a health savings account (HSA).
The average return from the stock market is about 10% annually. This holds true regardless of whether you invest through a taxable income account or tax-friendly retirement account.
Frequently Asked Questions
How can I find out how much interest I collected on my bank account?
Take a look at your year-end account information on your monthly bank statement. Or, contact customer service and ask for this information. All you need to do is find out the total amount of interest you collected in the previous year. This information should be easily accessible, and you may be able to obtain it online.
Does my retirement account have taxable interest?
It depends on what type of retirement account you sign up for. If you sign up for a Roth IRA, you won’t have to pay taxes on your funds when you go to withdraw them at retirement age. However, if you sign up for a traditional IRA, you can expect to pay taxes down the line.
In both cases, you’ll have to pay early withdrawal fees if you attempt to access your money before retirement age.
What is income tax?
Just as the name suggests, income tax is a financial tax that governments place on income. Individuals and businesses both have to pay federal income taxes.
However, state income tax varies from state to state. Some states require income taxes, while other states do not.
For example, Florida is a state that does not have an income tax. Connecticut and New York are both states that do.
In all states, workers still have to pay taxes to the federal government, regardless of where they live.
Will I get a tax refund?
It all depends on how much you pay in taxes throughout the year. If you work a full-time job and take out the maximum withholding amount for each paycheck, then you’ll most likely get a tax refund when you e-file or send in your paperwork.
If you work for yourself or don’t take out as much as you should in taxes annually, then you can expect to get a tax bill at the end of the year.
The Bottom Line
Investors who have interest-bearing non-retirement accounts have to pay taxes on all interest from the previous tax year. There’s no getting around this — even when we’re talking about a few measly dollars in interest from your checking account.
That means even if you generate a minuscule amount of taxes, the IRS is going to want to see how much you brought in, and it’s going to want payment on that obligation.
Still, there’s plenty you can do to reduce what you pay in taxes.
Get yourself a great tax advisor and start looking for legal ways to pay less taxes all around. Your future self will thank you.