What determines the tax rate applied to interest income?

The tax rate applied to interest income is primarily determined by the taxpayer's tax bracket. Interest income is generally considered ordinary income, which means it is taxed at the same rates applicable to wages and salaries. This means that the higher the taxpayer's overall income, the higher the marginal tax rate that will be applied to their interest income.

While different types of interest, such as municipal bond interest or interest from certain tax-advantaged accounts, may have unique tax treatments, the fundamental basis for taxing most interest income remains closely tied to the taxpayer's income level and tax bracket. As income levels rise, taxpayers might fall into higher tax brackets, leading to increased rates on the interest earned.

Other factors like residency status or how long the interest is held do play roles in various tax considerations but do not determine the fundamental tax rate for interest income. Thus, the tax bracket essentially dictates the rate applied to interest earnings.