What is tax-exempt interest income

Tax-Exempt Interest Income for Individual Taxpayers

Tax-exempt interest income is interest income that is not subject to federal income tax. Certain types of interest income may be fully or partially exempt from federal income tax. Below are the types of interest income that are commonly tax-exempt for individual taxpayers:

1. Interest on U.S. Savings Bonds

  - Series EE and Series I U.S. savings bonds interest may be tax-exempt if used for qualified educational expenses under certain conditions. The exclusion is calculated using Form 8815 and reported on Schedule B (Form 1040).

2. Interest on State and Local Bonds

  - Interest from bonds used to finance government operations and issued by states, the District of Columbia, or U.S. territories is generally exempt from federal income tax.

3. Interest on Certain Educational Bonds

  - Interest redeemed from Series EE and Series I bonds issued after 1989 may be excluded from income when used for qualified higher educational expenses, provided certain requirements are met.

4. Interest on Veterans' Insurance Dividends

  - Interest on insurance dividends left on deposit with the U.S. Department of Veterans Affairs is considered nontaxable.

5. Interest on Tax-Exempt Bonds

  - Interest income from Treasury bills, notes, and bonds is subject to federal income tax but exempt from state and local income taxes.

Reporting Requirements

- Taxpayers must report both taxable and tax-exempt interest on their federal income tax return, even if they do not receive a Form 1099-INT or Form 1099-OID.

- Tax-exempt interest must be reported on the tax return as it is an information-reporting requirement, although it does not convert the interest into taxable interest.

Additional Considerations

- Original Issue Discount (OID): If a bond, note, or other debt instrument was originally issued at a discount, part of the OID may need to be included in income each year as interest. For more information on OID and how to report it, refer to [Publication 1212, Guide to Original Issue Discount (OID) Instruments].

- Net Investment Income Tax (NIIT): Tax-exempt interest is not subject to the NIIT. However, individuals should be aware of the NIIT and its thresholds, which can be found in the [Questions and Answers on the Net Investment Income Tax].

- Nonresident Aliens: There are specific rules for nonresident aliens regarding nontaxable types of interest income. For more information, refer to [Nontaxable Types of Interest Income for Nonresident Aliens].

It is important for taxpayers to understand these rules to ensure proper reporting of tax-exempt interest income and to take advantage of the tax benefits associated with certain types of interest income.

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Sources:

Topic no. 403, Interest received | Internal Revenue Service 2024-08-03

Questions and Answers on the Net Investment Income Tax 2024-08-03

Publication 501 (2023), Dependents, Standard Deduction, and Filing ... 2024-08-03

Nontaxable Types of Interest Income for Nonresident Aliens 2024-08-04

Publication 970 (2023), Tax Benefits for Education | Internal Revenue ... 2024-08-03

Basic questions and answers about the limitation on the deduction for ... 2024-08-04

Foreign taxes that qualify for the Foreign Tax Credit 2024-08-03

Publication 929 (2021), Tax Rules for Children and Dependents 2024-08-03

Definition of adjusted gross income | Internal Revenue Service 2024-08-03

Publication 1212 (01/2024), Guide to Original Issue Discount (OID ... 2024-08-02