How is interest income taxed?
Last updated August 2026
Short answer
Interest gets the worst tax treatment of any common form of investment income. In a period of meaningful yields that matters more than it used to, and where you hold the interest-paying asset becomes a real decision.
No preferential rate exists
Qualified dividends and long-term capital gains have their own reduced rates. Interest does not. It is added to your income and taxed at whatever marginal rate applies.
For someone in the 24% bracket, $2,000 of savings interest costs $480 federally. The same $2,000 as a qualified dividend would cost $300 at the 15% rate.
State tax usually applies on top, and no state offers a preferential rate for interest either.
Taxable when credited, not when withdrawn
Interest is taxed in the year it is credited to your account, whether or not you take it out. Leaving it to compound does not defer anything.
A certificate of deposit paying interest annually is taxed each year even though you cannot access the money without a penalty until maturity. Multi-year CDs create tax bills on money you cannot yet spend.
The exception is a CD of one year or less that pays everything at maturity, where the interest is taxed in the year it is actually paid.
What each source looks like
Savings accounts, money market accounts and brokerage cash are fully taxable federally and by your state.
Treasury bills, notes and bonds are taxable federally but exempt from state and local income tax, which is worth real money in a high-tax state.
Municipal bonds are usually exempt from federal tax, and from state tax too for bonds issued in your own state.
Corporate bonds are taxable at every level, which is part of why they yield more.
Money market funds are not all the same
A government money market fund holding Treasury securities passes through a portion of its income as state-tax-exempt, and publishes the percentage each year.
A prime money market fund holding commercial paper is fully taxable.
A municipal money market fund pays federally exempt income at a correspondingly lower yield.
Brokerage sweep cash is usually fully taxable and often pays materially less than a money market fund at the same firm, which is a cost worth checking rather than assuming.
The 1099-INT and the $10 myth
Payers issue a 1099-INT when they pay you $10 or more of interest in a year. Below that they generally do not have to.
That threshold governs the form, not your obligation. Interest under $10 is still taxable income and still belongs on your return.
Interest can also appear on a consolidated 1099 from a broker rather than a standalone form, alongside dividends and sale proceeds.
Try it in Walnut
Walnut reads your connected brokerage positions, so cash and fixed income show up alongside everything else rather than being tracked separately.
Series I and EE savings bonds
Interest on I and EE bonds is exempt from state and local tax, and federal tax can be deferred until you redeem the bond or it stops earning interest.
That deferral is unusual and useful: it is one of the few ways to postpone tax on interest without a retirement account.
Interest may be entirely exempt from federal tax if the bonds are redeemed for qualified higher education expenses and your income is below a threshold, subject to conditions set out by the Treasury.
Where interest-paying assets belong
Because interest is taxed annually at ordinary rates, taxable bonds, CDs and cash-like holdings give up a slice of yield every year in a brokerage account.
Held inside a 401(k), IRA or HSA they compound untouched, which is why fixed income generally belongs in a retirement account when you have the room.
The exception is municipal bonds, already exempt, where a retirement account wastes the exemption and leaves you holding the lower yield for nothing.
Sources
Interest and dividend classification, and 1099 reporting, are in IRS Publication 550. 2026 rate thresholds are from IRS Revenue Procedure 2025-32, section .03. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax or investment advice; anything with a tax consequence is worth confirming with a tax professional.
FAQ
How is interest income taxed?
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As ordinary income at your marginal rate. There is no preferential rate of the kind qualified dividends and long-term capital gains receive. It is taxable in the year credited, even if you leave it in the account to compound.
Is Treasury interest taxable?
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Federally yes, but it is exempt from state and local income tax. In a high-tax state that exemption is worth a meaningful amount of yield, and it is why Treasury yields should be compared to corporate yields on an after-state-tax basis.
Do I owe tax on interest under $10?
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Yes. The $10 figure is the threshold above which a payer must issue a 1099-INT, not a tax-free allowance. Interest below that is still taxable income and still belongs on your return.
Do I pay tax on CD interest before maturity?
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Usually yes. Interest credited each year is taxable that year, even on a multi-year CD you cannot access without penalty. The exception is a CD of one year or less paying everything at maturity, taxed in the year it is actually paid.