Your savings account is a key part of your financial wellness plan. While savings accounts take very little effort to manage, they can be a huge help when you need quick access to your money for an emergency or one-off expense. Plus, they earn you interest.
Things get a little bit more complicated, however, when it comes time to pay your taxes. Some people don’t realize that the interest they earn on savings is subject to income taxes, so it needs to be reported at tax time.
There’s a good chance you owe taxes on some of the money in your savings account.
As far as the principal balance in your savings — that’s the part you personally deposit — those funds are not subject to tax, since you’ve presumably paid taxes on them already. However, the interest you earn on your account can be considered taxable income.
For example, let’s say you open a high-yield savings account (HYSA) and deposit $1,000. Then, over the course of a full year, you earn $35 in interest, bringing your balance to $1,035. For tax purposes, the IRS would only consider the $35 to be taxable income.
What does that mean for you when it comes to paying taxes? You’ll need to include your interest earnings on your tax return, and your tax bill can increase as a result. In fact, the interest you earn on all of the following accounts can increase what you owe:
Keep in mind that you only pay a portion of what you earn, so you get to keep the majority of your interest. The exact amount you owe will depend on your federal income tax bracket. You may have to pay taxes to your state as well.
Read more: What is taxable income (and how you can reduce it)?
It’s a bad idea to ignore your savings account interest when you file your taxes. For any tax year where you earn $10 or more, your bank will usually send a Form 1099-INT or 1099-OID to you — and to the IRS. That means even if you don’t report the interest, the IRS will still have the information.
What happens if your bank doesn’t send you the form? You’re still legally required to report the interest income. If you don’t, you could face some consequences, including:
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Interest charges: Compound interest can be charged on the unpaid taxers starting on the due date of the return.
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Failure-to-pay penalty: You might face a penalty of one-half of one percent for each month the payment is overdue.
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Backup withholding: Your bank can automatically withhold up to 24% of your interest payments in order to pay what you owe to the IRS.
The process of reporting interest earnings is pretty straightforward. Here’s how you can make sure your interest is included on your tax return and that you end up paying the proper amount:
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If you received a form 1099-INT or 1099-OID, take a look to see how much interest income you earned. If you didn’t receive the form, contact the bank to request a copy.
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For a standard tax return, add your savings account interest to form 1040 line 2b, which is labeled “taxable interest.”
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If you earned more than $1,500, list the names of the payers and the amounts you received on a Schedule B and attach it to your return.
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Pay your tax balance the same way you normally would, whether with a debit card, a bank transfer, or otherwise.
Read more: What if I can’t pay my taxes? 5 ways to manage your bill
The money you deposit to your bank account is not taxed, so you can deposit an unlimited amount. The interest you earn on your account, however, will be treated as income by the IRS and is subject to income taxes.
The IRS doesn’t monitor bank accounts, but it can potentially check your bank account if you owe back taxes or if you’re audited. When it comes to finding out about how much interest you earn on your savings, the IRS gets this information from reports that are filed by your bank.
The IRS can potentially freeze or levy any of your bank accounts. They can do this either by getting your written consent or with a search warrant, lawful subpoena or summons.
Read more: Frozen bank account: How it happens and what to do next
