Interest earned definition
/What is Interest Earned?
Interest earned is the amount of interest earned from investments that pay the holder a regular series of mandated payments. For example, interest earned can be generated from funds invested in a certificate of deposit or an interest-bearing bank account.
Accounting for Interest Earned
If the entity recording interest earned is using the cash basis of accounting, then the amount of interest earned will be based on the amount of cash actually received. If the accrual basis of accounting is used, then the amount earned will be recorded, irrespective of the amount of cash received. Under the accrual basis, you can record interest earned as long as receipt of the related amount of cash is probable, and you can reasonably estimate the amount of the payment. These differences in definition can mean that interest earned is recognized later under the cash basis of accounting than under the accrual basis.
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Presentation of Interest Earned
Interest earned may be recorded as an element of revenue, but can also be recorded further down the income statement, usually paired with the interest expense account. The latter presentation is more likely when the amount of interest earned is quite small, and is unrelated to the primary operations of the business. A sample presentation of this approach appears in the following exhibit.
Taxation of Interest Earned
In the U.S., interest income is generally considered taxable income and must be reported on your tax return. The taxation of interest depends on the type of interest earned:
Ordinary taxable interest. Most interest, such as that from savings accounts, checking accounts, CDs, and corporate bonds, is taxed as ordinary income at federal and state levels. It is reported on Form 1099-INT if it exceeds $10.
Tax-exempt interest. Interest from municipal bonds (issued by state or local governments) is exempt from federal taxes and may also be exempt from state taxes if issued by your home state. However, it must still be reported on your tax return.
U.S. treasury interest. Interest earned from U.S. Treasury securities (Treasury bonds, notes, and bills) is taxable at the federal level but exempt from state and local taxes.
Interest on series EE and I savings bonds. Interest on U.S. savings bonds is taxable at the federal level but can be deferred until the bond is cashed. If used for qualified educational expenses under the Education Savings Bond Program, the interest may be tax-free.
Interest from foreign accounts. Interest earned from foreign bank accounts is taxable in the U.S., and you may need to file additional forms, such as FBAR (FinCEN Form 114) and Form 8938, to report foreign holdings.
Interest income is typically reported on Schedule B (Form 1040) if total taxable interest exceeds $1,500. The tax rate depends on your ordinary income tax bracket, ranging from 10% to 37%.
The Difference Between Interest and Dividends
Interest earned is distinct from dividends, which are only paid to the holders of the issuing company's common stock or preferred stock, and which essentially equate to a distribution of the entity's retained earnings. The interest earned concept also does not apply to the appreciation of the price of a financial instrument.