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If you opened a money market account to take advantage of rising interest rates, you may be wondering if your successful savings habits are going to generate a sizable tax bill. Short answer: They might. The interest money market accounts earn is taxable by the IRS.
The good news is, taxes on your money market earnings won't exceed your earnings themselves, and reporting interest earnings on your taxes is easy to do. Here's what to know about how money market accounts are taxed.
How Money Market Accounts Work
A money market account earns interest like a savings account but also allows you to write checks or make limited debit card transactions. Money market accounts typically pay higher interest yields than regular savings accounts, and they're widely available at banks and credit unions.
Do You Pay Taxes on Money Market Accounts?
Interest you earn in a money market account is taxable as earned income. Any interest you earn on bank accounts, money market accounts, certificates of deposit (CDs), corporate bonds and deposited insurance dividends is taxable. Some distributions (or dividends) are also taxable as interest, including dividends on deposits or share accounts at credit unions and cooperative banks.
Two things to bear in mind: First, only the interest you earn is taxable. You are not taxed on your account balance. If you saved $8,000 in a money market last year and earned 4% annual percentage yield (APY), or $320, you would pay income taxes on $320—not $8,000.
Interest income is taxed at the same rate as your ordinary (employment) income. If you are in the 24% tax bracket, for example, you would pay $76.80 in taxes on $320 in interest.
How to Pay Taxes on Interest Earned From Money Market Accounts
Your bank or credit union tracks the interest you earn and reports it at the end of the year using a 1099-INT form. Financial institutions usually issue 1099-INTs in or around late January for the previous year.
When you're ready to complete your tax return, enter the interest from your 1099-INT forms on line 2b of your Form 1040. The amount you report on line 2b should include the interest you've earned from all of your interest-bearing accounts added together. If your taxable interest and dividends total more than $1,500, use Schedule B to list out each source of interest and the amount earned during the year.
What if You Don't Receive a 1099-INT?
Financial institutions are required to issue 1099-INT statements to account holders who earn $10 or more in interest for the year. If you received less than $10 in interest, you may not get a 1099-INT. You should still report the interest you earned on your tax return, along with any interest you earned from other accounts.
If you received more than $10 in interest and feel you should have been issued a 1099-INT, contact your bank or credit union.
What if Your 1099-INT Is Wrong?
Also reach out if you find an error on your 1099-INT. Your financial institution sends a copy of your 1099-INT to the IRS. In turn, the IRS matches up that information with what you report on your tax return. Discrepancies can raise red flags with the IRS—and may ultimately result in an audit. If you spot an error on your 1099-INT, ask your bank to issue a correction.
The Bottom Line
Although sending funds to the IRS might not be your favorite way to use your money, paying taxes on your money market interest is relatively simple. If you'd like to earn interest tax-free, consider putting your money into a tax-advantaged IRA, 529 educational savings plan or health savings account.
And if earning interest in a money market account is part of a larger campaign to keep your finances strong, don't forget to check your credit report and credit score regularly. You can keep an eye out for any changes to your credit file to help ensure that your credit remains in good standing, just like your money market savings.