Paying taxes is not the most enjoyable or straightforward experience. It is also quite sensitive as misfiling taxes can have serious consequences. People frequently ask me – “Do I have to pay taxes on my checking account?”
Whether you pay taxes on your checking account is an easy enough question. However, the answer requires a bit of understanding of how checking account taxes work. Knowing this will help you make sure you file your taxes correctly no matter what, which is why we’ve included as much information as possible.
Is A Checking Account Taxable?
The IRS (Internal Revenue Service) sets the requirements for what is taxable and what isn’t. To this end, all income – regardless of origin – should be declared and the relevant taxes paid.
This income includes everything from your employment income to any money you make from side gigs and even interest earned from some accounts.
Interest, for tax purposes, is a form of income and, therefore, taxable. It’s important to note that there are several exceptions, so not all earned interest counts as taxable income.
Not all checking accounts earn interest, but since many banks are offering better deals to attract customers, this is not always the case.
It is essential to point out that the only taxable amount on your checking account is the interest earned. You do not have to pay any tax on deposits you make, provided these were not pre-tax income.
Does your checking account earn interest?
Generally speaking, from a historical standpoint, checking accounts don’t earn any interest and therefore make no income. However, a shift in mindset has seen many banks offering interest on checking accounts.
The typical APY offered on a checking account is very small, with most banks offering 0.01%, meaning the amount you can expect to earn is minute.
To illustrate this with an example, if your average checking account balance over one year rests at $100,000, you can expect to earn $10 in a year. If your average checking account balance is $10,000 or over, a 0.01% APY interest rate will earn you one dollar.
Keep in mind that these figures are just an example. Several factors come into play when working out how much interest you earn, including the interest-eligibility criteria set by the financial institution where your checking account is.
If you recently opened your checking account and earned a welcome bonus, you need to include any money earned.
How to work out taxes on a checking account:
Not all income from interest is taxable – here are several exemptions. Interest is taxable in the year you earned it. As such, you need to work out how many interest payments from your checking account you received in the year you are filing taxes. If you received a bonus in the same tax year, you’d also need to add that.
Any income derived from checking account interest payments needs to be added to your other income (such as your ordinary income, also earned income) and then taxed at the applicable rate.
As with other tax payments, there are certain exemptions when paying tax on income derived from your checking account. One exemption is for income that doesn’t exceed the $10.00 threshold. In this case, no tax is payable on the income. However, you still need to declare it in your income tax return.
Another exemption worth noting is that the interest earned can be withdrawn without penalty for it to become taxable. While most checking accounts that pay interest allow you to withdraw interest without a fee or a penalty, the same is not true for other types of accounts (like IRAs and CDs).
Keep in mind that different financial institutions may structure accounts and interest payments differently. To avoid falling foul of the law, you should always check your account terms and conditions. When unsure, confirm with the bank/credit union, or speak with a tax professional to guide you.
Your financial institution should send you Copy B of Form 1099-INT provided that your total interest income exceeds $10.00. If you do not receive any of these forms, you are still obliged to declare any income to the IRS.
If the bank does not send you a 1099-INT form, you can download one online directly from IORS’ website and fill it in yourself. The form includes instructions and references to help you correctly fill and file it.
Depending on your finances, you may receive or need to fill in additional 1099 forms such as 1099-OID. You must ensure you fill in and return the correct forms depending on your particular setup.
Paying taxes on your checking account
The financial institution that holds your checking account reports any income you make from your checking account to the IRS. However, you still need to file it yourself. Fortunately, filing and paying taxes on your checking account is not that difficult, with several options available.
Step 1: Determine how much interest you have earned
The first step you need to take is to determine how much interest you have earned from your checking account. Your bank might send you a 1099 form, but this is not always the case. If you don’t receive one, check your bank statement to see how much interest you have earned the year you are filing taxes. You might want to call or email the bank if you get stuck for help.
Remember to check if you apply for exemptions before determining how much interest you have to pay. We covered this earlier in the article – however, it’s worth noting that the IRS may amend the list of exceptions in the future. Check the Inland Revenue Website for the latest exemptions to make sure you don’t overpay.
Step 2: Fill out the 1099-INT form
Once you have determined how much you need to pay, you’ll need to fill in the 1099-INT form. The taxable amount appears in box one, which must also be accounted for in the taxable interest section of your tax return.
If you paid any penalties on early withdrawals, these need to be listed in box 2, while tax-exempt interest is in box 8. Fill in the rest of the form as required, and be sure to reflect the correct amounts in your tax return.
Step 3: Pay amounts due
Once you’ve filled everything in, all that’s left to do is pay whatever is due to the IRS. How much you need to pay will depend on the applicable tax rate for your tax bracket. You can use tax filing software or consult a tax advisor if you get stuck or find the filing too complicated. Late filings can incur penalties, so always make sure you file on time.
The IRS accepts many forms of payment to settle your tax dues, making the entire process super easy.
If you e-file your taxes, you can use an Electronic Funds Withdrawal; otherwise, you can choose from Direct Pay from your checking account or savings account, through a debit card or credit card, or even pay with cash. Alternatively, if you do not have the full amount, you can choose to set up an installment agreement and pay monthly.
Planning is one of the best tools for your personal finance. You can’t avoid taxes that are due to the IRS. Doing so is illegal and often carries hefty repercussions. It is always worth investing time in your money to make sure that you’ll be able to sail plainly when the waters get rough.
Set money aside
If you’re self-employed or have sources of income other than your full-time job, it’s a good idea to set money aside. Make this a habit every time you get paid to make sure you can cover due taxes, including social security and Medicare. By setting money aside, you’ll have enough funds to cover any tax monies due come tax season, and if you’re extra careful, you might also have something left over.
Speak to a tax advisor
Depending on how complex your income situation is, you might want to speak to a tax advisor to see how you can optimize your finances. While this might not come free, it can help you save money on tax payments while offering peace of mind that everything is above board.
How To Lower Your Tax Bill
You can structure your finances in certain ways to lower the tax you need to pay. These types of accounts are tax-deferred or tax-exempt. However, there is always a catch. Even so, investing in such accounts can help you achieve future goals, which might be beneficial either way.
Traditional IRAs (Individual Retirement Accounts) are popular retirement plans. You can make pre-tax contributions while your money will grow tax-deferred until you make withdrawals.
Roth IRAs work slightly differently than Traditional IRAs. Contributions can be made after-tax, which won’t help you in the short term. Contributions and earnings, however, will grow tax-free, so you can withdraw money without paying tax after you become eligible to do so.
HSA is short for Health Savings Account. You can make pre-tax contributions and get tax-free earnings and distributions. Money can only be used for qualified medical expenses and can rollover. Yearly limits apply regarding how much funds you can contribute to your HSA.
Earn interest on your tax money
Have you ever needed to pay a significant amount of tax? Chances are, you could be making money by keeping that amount in an account with a higher interest rate!
Here are some bank accounts you might want to consider keeping (and growing) your money.
High-yield savings account
High-yield savings accounts are just like traditional ones but offer a higher APY interest rate.
You’ll mostly find these types of accounts at online banks, which can offer better savings account interest due to having lower overheads. Some traditional banks offer them as well to attract customers, so it’s always worth checking for
Keep in mind that some checking accounts have a monthly withdrawal limit, so you won’t be able to stop by an ATM whenever you want.
This limit was put in place through Regulation D – a Fed regulation that limited withdrawals from savings accounts to six per month. While the regulation has been repealed, some banks chose to keep the limit in place.
Certificates of deposit
Certificates of deposit, known as CDs for short, are a type of savings account with a fixed term. Terms typically vary between three months and five years, with higher interests the longer the term.
Early withdrawals are subject to a penalty fee which can very well wipe out any interest you’ve earned and, in some cases, a percentage of the deposited amount. As such, waiting until the maturity date – the end of the fixed term – is highly recommended.
If you’re concerned about access to money, you can always build what is known as a CD ladder. Here, you open several CDs with different terms so that a CD is close to expiry every so often. In doing so, you don’t have to potentially wait for five years to get access to your money and still get to enjoy good interest rates.
Since you can’t withdraw CD interest without paying the penalty, you don’t have to declare it in your tax returns yearly – only when withdrawing the money.
Money Market Accounts
Think of Money Market Accounts, known as MMA for short, as a hybrid deposit account that takes the best of checking and savings accounts.
You typically get a good interest rate and a debit card – but withdrawal limits might be in place. While this is not always the case, it is something that you can easily get around with a bit of planning. Make sure you leave some leeway to cater to emergencies without paying any penalty fees.
Frequently Asked Questions
How much money can you have in your bank account without being taxed?
The money you have in your bank account isn’t taxed – but any interest grown on top of that money is. So, you can have any amount in the bank without paying taxes on that money, as long as it isn’t earning you interest.
Do I need to file taxes for a checking account?
Yes, the IRS requires all taxpayers to report interest earned from all taxable accounts, including checking accounts. But that’s only if your checking account generates money.
Do I have to pay taxes on my bank account?
You only need to pay taxes on any income you make from your bank account. While typically, this means interest income, if you have received a welcome bonus or another type of bonus, you need to include it in your taxable income.
Tax is payable in the year that you can withdraw income without penalty fees. Be sure to check when this is to avoid paying taxes twice on the same amount.
Certain accounts, such as CDs, only allow you to withdraw money once you hit the maturity date, while accounts such as Traditional IRAs are tax-deferred. Double-checking bank statements can be helpful for taxpayers.
What is interest income?
Interest income is any income you earn through interest. Interest is paid as an APY, calculated as a percentage of the money in your checking account. Most checking accounts do not earn interest – and the ones that do usually earn very little.
What is taxable income?
Taxable income is any income earned that the IRS defines as taxable. Interest payments are taxable income, as are welcome bonuses, your employment income, side-gig income, and others. If you are unsure whether a specific type of income is taxable or not, refer to the IRS website or consult a tax professional.
Are checking account welcome bonuses taxable?
Yes, any welcome bonus earned from opening a checking account is taxable. You should include the amount in the 1099-INT form for the year it was earned and included in your tax return.