The past few years have been banner years for earning interest on everything from high-yield savings accounts to CDs and other interest-earning financial products. With banks and institutions offering sometimes as much as 5% APY, many Americans have been able to passively grow their wealth.
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While passive income is a very welcome thing, as tax time rolls around, there are some important things you need to know about that interest, so you aren’t caught off guard owing more money than you expect and other considerations.
Mark Gallegos, a CPA with a master’s in science and taxation and a tax partner with Porte Brown, LLC, explained six things you need to know about that interest you earned this year.
Earned Interest Is Federally Taxable
While your interest may feel like extra money you can keep all to yourself, don’t forget that the IRS would like its cut first (and some states as well).
“Interest income is considered taxable income by the IRS. This means you must report it on your federal income tax return regardless of whether the interest is from a traditional or a high-yield account,” Gallegos said.
Depending on just how much you earned, if you haven’t put aside extra to account for this, you could be smacked with a tax bill.
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Some States May Tax It Too
Depending on where you live, Gallegos said your state might also tax your interest income.
“So you want to check what’s the reportable requirements for your state.”
Don’t confuse your earned interest with tax-exempt interest, such as what you earn from a municipal bond, he said. “That gets reported on Schedule B and goes to a line on a 1040 form that says tax exempt income and you’re not taxed on it.”
You Should Receive 1099-NT Forms
If you earned more than $10 in interest from anything like a CD, bank account, brokerage account, money market, bonds or so on, you should receive an IRS form known as a 1099-NT. This form shows the IRS how much each of these institutions paid you. You will file this with your taxes. However, keep in mind that if, for any reason, you do not receive that 1099-NT but you did earn interest, you still need to report it on your taxes.
“So for example, one bank may give you an interest form that shows, hey, I got a $100 dollars of interest and maybe another bank, you only earn $6. That bank that you earned $6 from is not required to send you a 1099-INT. However, you should report the $6 from that bank on your tax returns,” Gallegos said.
If you didn’t get such a form, you can typically find interest earned on the last statement of the year, he suggested. You’ll report this income on what’s known as a Schedule B on your taxes if you’re not also a freelancer or self-employed small business (in which case it would be a Schedule C).
Earned Interest Can Change Your Tax Bracket
Because interest is another form of income, Gallegos warned, “Large amounts of interest income could potentially push you into a higher tax bracket, increasing basically your marginal tax rate on all your income.”
This could affect things like Social Security income taxes and just generally increase the amount you pay in taxes or lead to a tax bill.
Failure To Report Can Lead To Penalties
If you didn’t receive 1099-NTs or didnt reportthat income to the IRS, you can be charged penalties for failing to report — and the IRS will come collecting.
“Making sure you have everything covered is always key,” Gallegos said.
Earned Interest Is Still Worth It
While there are risks of earning interest, and high interest rates overall drive inflation and make loans more expensive, if you’ve been able to take advantage of high interest to earn passive income, just be smart about how you prepare for the taxes, Gallegos said. Additionally, you can buy U.S. treasury bonds to lock in a high interest rate before rates drop.
“I’ve seen people get some huge money, especially when they’ve had enough to invest in them,” he said.
If you’re been savvy enough to earn a significant amount of interest, consider yourself lucky but be prepared at tax time.
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This article originally appeared on GOBankingRates.com: 6 Things You Need To Know About the High-Yield Interest You Earned This Year
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