Taxes are sure and non-negotiable. It can’t be put any better than POTUS Benjamin Franklin, in 1789, “Nothing is certain except death and taxes.” All governments are very stringent with tax laws and have extensive punitive measures to deal with tax evasion—the illegal activity of a person or entity deliberately and consciously avoids paying or revealing their true tax liability.
While there are cases of deliberate tax evasion, some are different. There are many cases of ignorance (lack of information) on what constitutes a person’s tax liability. Most people only know they will be taxed on their basic salary, corporate tax, and value-added taxes (VAT).
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What about the savings, for instance? There are many scholarly articles around the area of “Do I have to pay taxes on my savings account” that can help you learn more about taxes and savings accounts.
Are Saving Accounts Taxed?
Contrary to the expectation of many people saving accounts are subjected to taxation. Suppose you deposit money in a traditional savings account. In that case, every interest earned is considered taxable income by various government bodies in charge of tax administration and collection from individual and corporate taxpayers.
Taxable income encompasses interest people earn on their usual savings accounts, certificates of deposits (CDs), high-yield savings accounts (HYSA), and deposit accounts in money markets.
Whereas savings accounts are not generally considered investments, they earn money in the form of interest. Most tax regulating bodies, like Internal Revenue Service (IRS), regard the interest earned on savings as taxable income. This position stands whether the money is kept in the account, transferred to another account, or withdrawn.
So, when your bank pays you interest during the fiscal year, you automatically earn a tax liability on interest. Banks normally notify their customers early in the following tax year liability through a tax form. Whether or not you receive the form, you have a responsibility to disclose your interest income, even if it is just a few bucks.
The next big thing is to understand how this tax on savings interests works and the rate they use.
How Interest From Savings Accounts Are Taxed
It is important to know how the interest from savings accounts gets taxed. For instance, what rates do they use to calculate what goes to the national exchequer?
As a principle in most tax regimes, interest from savings accounts is taxed at the account holder’s earned income tax rate for that specific year. The tax is treated as an increment to your earnings and thus taxed at the same rate as your income tax rate.
Usually, your bank will notify you of your Savings Account interests earned in the past year through a tax form. However, it is crucial to note that this notification only applies to those with less than $10 interest.
All in all, disclosing your savings account interest is wholly yours. If your bank does not notify you, you, instead of the bank, will have the burden of proof to defend yourself against possible tax evasion.
Tax laws require that you report everything, even if the interest is less than $10. As long as you have a savings account, you should be on the lookout to see if anything needs to be reported as you file your taxes to avoid penalties. If you don’t receive a notification from your bank, it indicates two things.
The first could indicate that you are yet to earn interest on that savings account. Secondly, it would mean that your interest is less than the bank’s notification threshold of ten bucks.
Are There Exceptions to Taxes on Savings Interest?
This should be a relief to you if it applies to you. There are some exceptions to taxes on interest, and these exceptions mostly apply to special accounts. These special accounts allow the savings interest to accrue tax-deferred (taxes deferred until retirement). With these accounts, you are exempted from the annual reporting of the earnings on the account as taxable.
In the U.S., accounts with such privileges include traditional and Roth individual retirement accounts (IRAs). IRA is a long-term savings account that enables individuals with earned income to save for the future, and it comes with tax privileges. It is important to note that IRAs only apply to self-employed individuals.
The self-employed group cannot access workplace retirement accounts accessible only through employers. Other recognized accounts include Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plan for Employees (SIMPLE) IRAs.
For those who are employed, IRAs don’t apply. Instead, they can access exceptions to taxes on saving interests through 401(k) accounts that can be accessed through their employers.
In a traditional IRA (for the unemployed or self-employed) or 401(k) account (for the employed), individuals don’t owe taxes on their account or its earnings as long as they are still accumulating the money. Saving income taxes liability applies to both when the account holders withdraw their savings, which most people do after retirement.
Roth IRA works a little differently. Annual income tax is already paid when you deposit money into Roth IRA. Therefore, the principal and income earned are exempted from taxation as long as you don’t withdraw the savings until you turn 59.5 years of age.
Interests earned on savings accounts are generally treated as income and therefore subjected to taxation at the same rate as the annual income tax rate. You must disclose your earnings from the savings accounts and honor your tax obligations accordingly. Some exceptions cater to the self-employed as well as those who are on employment.