7916 / How is interest taxed earned on a time or savings deposit? In what year should the interest be reported?

Generally, any interest earned on time or savings deposits is ordinary income that must be included in the account owner’s gross income.¹ Because “interest” in this sense includes any compensation paid by the financial institution for the use of its depositors’ money, many distributions commonly referred to as “dividends” are actually payments of interest and will be taxed as such.² These include “dividends” on deposits or share accounts in cooperative banks, credit unions, domestic building and loan associations, federal savings and loan associations, and mutual savings banks. On the other hand, dividends on the capital stock of such organizations should be reported as dividends and not as interest.³ Although “interest” and “dividends” are taxed in the same manner, except for the special treatment of “qualified dividends,” the distinction is still made for reporting purposes.

“Dividends” received from a mutual savings bank that received a deduction under IRC Section 591 are not eligible for the 20/15/0 percent rates applicable to “qualified dividend income” (see Q 702).⁴

Generally, interest must be included in gross income for the year in which (1) it is actually received by the taxpayer or, if earlier, (2) it is constructively received by the taxpayer.⁵ Interest is constructively received by a taxpayer in the year during which it is credited to the taxpayer’s account, set apart for the taxpayer, or otherwise made available so that the taxpayer might draw upon it at any time, or so that he or she could have drawn upon it during the year if notice of intention to withdraw had been given.⁶ Interest may be constructively received even though the taxpayer was never notified that the interest was available.⁷ On the other hand, interest is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions (see Q 662).⁸