Editor’s note: Please be aware that we’re not tax professionals and this is not tax advice, just a general guideline.
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High yield savings accounts have a major advantage over your typical savings account at a brick-and-mortar bank: you can actually earn a noticeable amount of interest. But if you recently switched to a high yield savings account, you may find that this advantage comes with one small asterisk when you file your taxes this year: a smaller tax refund.
Why do I have to pay taxes on my high yield savings account?
It all boils down to income. The IRS recognizes two types of income:
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Earned Income: This is money you receive in exchange for work including your W-2 job, 1099 contract work, and self-employment income.
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Unearned Income: This is money you receive from sources outside of working such as dividends from your investments, capital gains from selling your investments, and yes, interest earned on your savings.
The government wants a piece of all of your income, including your unearned income. Keep in mind that you are not taxed on the money that you have in your savings account, just the interest that you earned from it.
How do I pay taxes on the interest I earned?
Unlike with your job, taxes are not withheld on your savings interest. Instead, you will receive a Form 1099-INT from your bank by January 31st in one of two ways:
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In the mail: Keep an eye out for mail from your bank and ensure that your address is up-to-date with them.
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Online: If you have opted for electronic-only communications from your bank, you will receive an email telling you that your tax documents are available. You’ll then need to log into your online account to access your 1099-INT.
If you use tax prep software, at some point in the process it will ask if you had any unearned income. This is your cue to pull out your 1099-INT. In Box 1 of the 1099-INT you’ll find your total interest earned on that account. Once you enter this number, you’ll see those refund numbers at the top of the screen decrease. Console yourself with the knowledge that you’re only paying taxes because you made money.
How can I avoid paying taxes on my savings account?
You can’t—at least not if you earn more than $10 of interest. If you really want to avoid paying taxes on interest, you can keep your savings with a traditional bank where you’re unlikely to make more than $10 of interest annually. No income equals no taxes, but also less money overall!
Final Thoughts
Although it’s never fun to see your tax refund decrease (or even end up owing), when it comes to a 1099-INT, it’s a sign that you maximized the earning potential on your cash accounts. That’s something to celebrate!
