What Is Interest?

Interest income is earnings on the use of your deposited money. Dividends are amounts paid out of earnings and profits of your investments. Generally, the payor of the income amounts you receive will distinguish between interest and dividends, and will send you the appropriate form reporting the correct dollar amount you received during the year.

Some items that you might consider to be "interest" are treated as dividends by the IRS. For example, income earned on money market funds offered by non-bank financial institutions such as mutual funds and stock brokerage houses should be reported as dividends, not interest. On the other hand, some things you might think of as "dividends" are treated as interest, such as dividends from tax-free municipal bond funds.

Other items that are commonly called "dividends" but that are treated as interest and reported in Part I of Schedule B are income from accounts in cooperative banks, credit unions, domestic building and loan associations, domestic savings and loans, federal savings and loans, and mutual savings banks.

When to report your interest income depends on whether you use the cash method or an accrual method to report income. Most individual taxpayers use the cash method. If you use this method, you generally report your interest income in the year in which you actually or constructively receive it. However, there are special rules for reporting the discount on certain debt instruments. See original issue discount on bonds.

Special rules also apply to tax-exempt interest and U.S. government obligations.

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