How is interest income typically taxed?

Interest income is typically taxed as ordinary income because it is considered a return on your investment that does not gain preferential treatment under tax laws. This means that any interest earned from sources such as savings accounts, CDs, or bonds is added to your total income and taxed at your marginal tax rate, which can vary based on your overall income level.

The rationale behind taxing interest income this way is that it is a straightforward form of income, unlike capital gains, which arise from the sale of investments and could have different tax treatment. This traditional approach ensures that individuals report all sources of income consistently under the same framework.

In some cases, there can be exceptions, such as tax-exempt bonds where the interest earned is not subject to federal tax, or certain thresholds that might apply to other forms of income, but these do not negate the general principle that interest income is included in ordinary income for taxation purposes. Thus, labeling it as taxable at a lower capital gains rate or exempting it goes against the established tax treatment for most interest income.