Higher interest rates produce a surprise for some: Taxes on savings

The flurry of documents that fills Americans’ mailboxes at the start of tax season included pieces of paper this year that many people had not seen in a long time, if ever: 1099-INT forms, reminding them that they owe taxes on the interest in their bank accounts.

The forms left some taxpayers scratching their heads, like the one who tweeted: “Is it new this year that we have to pay taxes for interest earned on savings accounts? I don’t recall ever having to do that.”

For most of the past 20 years, interest rates were so low that many people earned very little on their bank deposits. But rates soared in 2022 and the first half of 2023 as the Federal Reserve battled inflation, so savings accounts now regularly pay more than 5% in interest after paying close to zero for years.

This year, people have been asking frequently about bank-account tax forms, Indiana-based tax preparer Matthew Cordes said.

“There’s some confusion,” Cordes said. “Some people think if they … don’t take it out and put it in their pocket, then they don’t have to pay tax on it. That’s obviously not true.”

Technically, any interest is taxable, but banks are only required to send 1099-INT forms – reporting taxable interest to the IRS and to the taxpayer – if the interest exceeds $10.

At an interest rate of 0.06 percent, which was common for many savings accounts until the past year and a half, someone would have needed more than $16,000 in their bank account all year to earn $10 in interest. At a rate of 5%, an account with just $200 can generate $10 in interest.

That means a lot more 1099-INT forms in the mail this year, and a lot more people who have to figure out how to report interest on their tax returns.

In 2022, banks sent 1099-INT forms to the holders of more than 155 million bank accounts, according to IRS statistics. This year, the agency predicts more than 183 million are being sent.

When the Congressional Budget Office updated its predictions this month, it forecast that taxpayers would report $327 billion of taxable interest in 2024, up from $237 billion in 2019, the last year for which the actual total is available.

Reporting the income doesn’t require much work. Most taxpayers can give the 1099-INT form to their tax preparer or type the number on the form into tax preparation software. Those who fill out their own tax forms will write one number from the 1099-INT, the total amount of taxable interest, on their 1040 on line 2, below their wages, where they see the words “taxable interest.” The amount gets added to their total taxable income, to calculate how much tax they owe.

For some, the tax implications are substantial. Cordes said some of his clients are retirees on a fixed income, with most of their savings invested in interest-bearing certificates of deposit. Some people who have six-figure investments have been surprised by a tax bill of hundreds of dollars or more, based on interest earnings in the thousands of dollars.

“Now all of a sudden, we’ve bumped them up quite a bit,” Cordes said. But the increased interest earnings more than makes up for the tax surprise, he said: “It’s never a bad thing to make more money.”