Income can be earned through investments with capital in the form of capital gains, dividendsand interest. Every year, investors pay taxes on interest income bonds, mutual funds, certificates of deposit (CD), and demand deposit accounts. Some types of interest are fully taxable, while others are partially taxable.

Types of Interest Income

Interest is part of the lending and investment industry. Lenders charging interest to borrowers for using their capital as debt, such as loans and mortgages. The money these lenders earn in interest is called interest income.

Investors depositing money into different investment vehicles to generate a return, usually in the form of interest. This is called interest income. The main types of interest income an investor can earn are:

How is interest taxed?

Regular taxable interest is taxed as ordinary income, as a individual retirement account (IRA) or retirement plan distribution. Interest income is in addition to the taxpayer’s other ordinary income, such as wages or salaries. This total income is used to calculate marginal tax rates.

This rule applies to interest that is both fully taxable at all levels and to interest that is taxable only at the federal level. Some United States government bonds are taxable at the federal level only. Municipal bond interest is exempt from all taxes, unless alternative minimum tax (AMT) applies.

Marginal tax rates

The IRS sets tax rates based on inflation each year. When filing taxes in 2024, taxpayers apply the marginal tax rates for 2023. When filing taxes in 2025, the marginal tax rates for 2024 apply.

2024

• 37% for individual income above $609,350 or $731,200 for married couples filing jointly
• 35% for individual income above $243,725 or $487,450 for married couples filing jointly
• 32% for individual incomes above $191,950 or $383,900 for married couples filing jointly
• 24% for individual income above $100,525 or $201,050 for married couples filing jointly
• 22% for individual income above $47,150 or $94,300 for married couples filing jointly
• 12% for individual income above $11,600 or $23,200 for married couples filing jointly
• 10% for individual incomes below $11,600 or $23,200 for married couples filing jointly

2025

• 37% for individual income above $626,350 or $751,600 for married couples filing jointly
• 35% for individual income above $250,525 or $501,050 for married couples filing jointly
• 32% for individual incomes above $197,300 or $394,600 for married couples filing jointly
• 24% for individual incomes above $103,350 or $206,700 for married couples filing jointly
• 22% for individual income above $48,475 or $96,950 for married couples filing jointly
• 12% for individual income above $11,925 or $23,850 for married couples filing jointly
• 10% for individual incomes below $11,925 or $23,850 for married couples filing jointly

Form 1099-INT and Form 1099-OID

Any institution that grants interest to an individual must send Form 1099-INT to all recipients before January 31 of each year. Banks and investment companies must submit the form for interest over $10. This form shows the amount and type of interest paid during the year.

Form 1099-INT has several different boxes that list different types of interest income:

• Box 1 (Interest income): The amount of regular interest paid from fully taxable instruments such as corporate bonds, mutual funds, CDs, and demand deposit accounts.
• Box 2 (early withdrawal penalty): The total amount of early withdrawal penalties for CDs or other securities you paid during the year. This amount is considered an above-the-line deduction on 1040.
• Box 3 (Interest on U.S. Savings Bonds and Treasury Bonds): This number appears on a different line on Schedule B because it is only federally taxable. The income from this box is distinct from the income from box 1.
• Box 4 (Federal income tax withheld): The total amount of backup retainer on your interest income. Most interest payers must withhold tax at a rate of 24% if the investor fails to provide their tax identification number or social security number (SSN) or provides an incorrect number. This number is added to the amount of your employer’s withholding on the 1040.
• Box 5 (Capital expenditure): The total amount of deductible expenses relating to your investment income from a single category real estate mortgage investment conduit (REMIC).
• Box 6 (foreign tax paid): Any tax on your interest income paid to a foreign country. If the foreign country has a tax convention with the United States, this tax is generally either a deduction or a tax credit.
• Box 7 (Foreign country or US possession): The foreign entity to which the tax in box 6 was paid.
• Box 8 (Tax-exempt interest): Any interest exempt from all levels of tax for any reason, including excluding taxes dividends from mutual funds or others regulated investment companies. This figure is reported on line 2a of 1040.
• Box 9 (Interest from specified private activity obligations): This box reflects the tax-exempt interest which is subject to the AMT. This amount is also included in box 8.

Taxpayers may also receive Form 1099-OID for taxable interest. Form 1099-OID reports original emission reduction instruments; If a taxable bond or other debt instrument was issued at a discount, a portion of the original issue discount may be included each year as interest income. A Form 1099-OID is issued to taxpayers receiving original issue taxable rebates of $10 or more.

Taxpayers may also be named designated beneficiaries of taxes and receive a Form 1099 for interests in their name owned by someone else. The IRS has a set of instructions for reporting this income as part of Schedule B of Form 1040. You must also prepare a Form 1099 to submit to the IRS, unless the nomination is from a spouse .

Tax returns

An accounting or tax preparation program or software will enter all data from the forms (1099-INT, W2, and others) into Form 1040, the standard form. Internal Revenue Service (IRS) form that all individual taxpayers file each year.

Investors can also report all interest income received for the year in Part 1 of the Appendix B: Ordinary interest and dividends of 1040. Any investor who receives a Form 1099-INT must be able to correctly transcribe the information on Schedule B of their tax return or IRS Form 1040.

Tax-exempt income

Types of tax-exempt income include:

• Interest earned on certain types of municipal bonds, such as bonds issued by state and local governments
• Interest earned on certain U.S. savings bonds, such as Series EE and Series I bonds, is exempt from state and local income taxes.
• Government bonds such as Series HH bonds and Treasury Inflation-Protected Securities (TIPS) may also be tax-exempt.
• Interest earned on 529 plans is generally exempt from federal taxes.
• Money held in retirement accounts such as traditional IRAs or 401(k)s is generally tax-free until the funds are withdrawn.

Interest and dividends

Interest income is generally taxed as ordinary income and is subject to the same tax rates as wages and salaries. Dividend incomesuch as qualified dividends, may be subject to long-term capital gains rates depending on the taxpayer’s income level and length of holding.

Dividends are paid from a company’s funds after-tax income. Interest is paid on pre-tax income. Companies that pay dividends face double taxation: once on their profits and another time on the dividends they pay to shareholders. Alternatively, interest payments are tax deductible for businesses and more beneficial as they can be used to reduce tax payable.

The essentials

Investors save money to earn dividends, capital gains, or interest. Whatever form it takes, it’s all considered income. Taxpayers must report this along with any other sources of income received during the tax year. Investors should be on the lookout for Form 1099-INT from financial institutions or investment firms after the end of January. This form shows the amount of interest earned and what will be reported to the IRS.