Tax Prep Note: Interest Income and Munis

When most people think of taxes, they start thinking about deductions and credits. When you are getting your tax preparation checklist together, however, it is also important to think about what Uncle Sam considers income. This is especially important to consider since the recession has inspired many people to save more — and even to invest in bonds. Those who are a little more adventurous with their money are even investing in municipal bonds, which are considered riskier than Treasuries. What many don’t understand is that the interest earned on savings accounts is taxable. And so are the capital gains on some municipal bonds.

Interest income

When you earn interest on your savings account, you are required to report it. Interest income is taxable. There’s a special place for it on form 1040 — right there on line 8a. Your banks should send you a 1099-INT statement. Some banks, however, don’t send the form unless you earned more than $10 for the year. But you are still responsible to report the income, even if the bank doesn’t send you statement. If you earned more than $1,500 in interest, you will be required to fill out Schedule B and file it along with your 1040.

Municipal bonds

Many people like to invest in municipal bonds because you can get a better return than investing in federal Treasury bonds. Another tempting reason is that, for many  municipal bonds, you do not have to pay taxes on the interest earned. However, this doesn’t mean that you do not have to pay tax at all. The capital gains tax may still be in effect for your municipal bond investments. Make sure that you understand the tax rules attached to municipal bonds — or you could find yourself audited.

image source: sxc.hu