Money market deposit accounts are a type of savings account offered by banks and credit unions. The Internal Revenue Service requires account holders to pay tax on interest earned on money market accounts and other types of interest-paying deposit accounts. The institution holding the deposit should send you a 1099-INT form that details the amount of interest you earn each year. You use the 1099-INT form to complete your taxes.
Money Market Accounts
Money market accounts are designed for savers who typically keep large amounts of money on deposit but want to earn a better rate of return than banks pay on regular savings accounts. Money market accounts are liquid and customers can make withdrawals up to six times per month. Due to the liquidity of money market accounts, the interest rates are lower than the rates paid on illiquid accounts such as certificates of deposit.
Banks and credit unions only mail out 1099-INT forms if your received more than $10 of interest during the year. However, just because you did not receive a 1099-INT does not mean that you are exempt from paying tax. You must determine how much interest you earned by reviewing your bank statements. The IRS assesses tax on the total interest you earned and not just the interest earned on one specific account. Therefore some people earning minimal amounts might be better to keep funds in non-interest bearing accounts rather than risk having a small amount of interest push them into a higher overall tax bracket.
Tax-Exempt Money Market Funds
Some investors confuse money market accounts with money market mutual funds. Money market mutual funds are conservative investments that contain short-term securities such as bonds. Money market funds that contain municipal bonds are generally tax-exempt because the IRS does not assess tax on interest received from municipal bonds. If you buy money market mutual funds that are not tax exempt, the earnings are classified as dividends as opposed to interest but are taxable at the federal level.
Some people open money market accounts under the name of a trust to reduce their personal tax liability. If you have funds in a money market set aside for a child's college expenses, you can open the account under the child's name and act as the custodian on the account without having to pay taxes on the interest. However, once you open the account under the name of a trust or a minor, you technically no longer own the money deposited into the account.