You call it making your money work for you. The IRS calls it unearned income. Regardless of the name, the earnings from your savings accounts, stocks and bonds, certificates of deposit and mutual funds have tax implications. Surprise, as your nest egg grows, so do your taxes.

Interest income

Most of us have had a savings account that earned interest. It’s an easy and safe way to accumulate some money that you don’t plan on using for a while, or that you’re saving to buy that car or special gift. Your bank calculates the interest you earn regularly and lets you know how big your account is getting. But if you don’t withdraw it, there shouldn’t be any tax issue, right?

Not according to the IRS. Any interest credited to a nonretirement account and that you can withdraw is viewed by the taxman as income to you, even if you leave it untouched. Each January, you should receive from your bank a form showing how much interest your account earned. A copy of this form, called a 1099-INT, also goes to the IRS to make sure that tax payments on it don’t fall through the cracks.

All three individual tax forms — 1040EZ, 1040A and 1040 — have specific places for reporting interest income: the line immediately following your wages entry. You can only use the 1040EZ if your interest income is less than $1,500. If it’s more than that, and especially if it’s from several different accounts, you’ll need to use the 1040A or 1040 and their accompanying interest attachments. With the 1040A, you’ll list all your accounts and the interest earned on Schedule 1; it’s Schedule B for the longer standard 1040 form.

Once you total all the interest on the proper schedule, then you transfer the amount to the main form to add it to your salary and other income.

Dividends and distributions

That passbook account was nice, but in your quest to maximize your investments you branched out into stocks and bonds or opened a mutual fund account. This also means that your tax filing on the income from these gets a bit more complicated.

Companies periodically pay shareholders a portion of their earnings and profits, known as dividends. You cannot use Form 1040EZ if you receive any dividend income, so you’ll need to report the income on either Form 1040A’s Schedule 1, or Schedule B that accompanies the Form 1040.

Dividends are the most common type of distribution from a company’s stock. Thanks to tax law changes, qualified dividends are now taxed at a lower rate. If you have mutual funds, you might also receive capital gains distributions. A capital gain is any profit on the sale of an asset, such as stock or real estate. In the case of mutual funds, when the fund itself realizes a long-term capital gain, it pays out a portion of that to account holders as a long-term capital gains distribution, which also gets more favorable tax treatment than regular income.

The annual tax statement (1099-DIV) you get from your account manager will tell you what amounts are eligible for this preferential tax treatment (and where to enter them on which form). In most cases, such earnings mean you must file a 1040 because the 1040A allows you to report only ordinary dividends. And depending on your overall portfolio and investment moves you made during the tax year, you might have to fill out some additional tax paperwork (Schedule D or a tax computation worksheet) at filing time.

Dividends that are interest

Some institutions call their payments to you dividends, but the IRS classifies these distributions as interest. If you get a “dividend” statement from any of the institutions listed below, this money should be reported in the interest section of your tax form:

  • Cooperative banks
  • Credit unions
  • Domestic building and loan associations
  • Domestic savings and loan associations
  • Federal savings and loan associations and
  • Mutual savings banks.

However, money market fund payments are, for tax purposes, considered dividends.

Backup withholding

Your interest and investment earnings are taxable, but generally no withholding tax is taken out of the accounts. However, in some cases the accounts may be subject to backup withholding. This usually happens if you don’t give the bank your Social Security number. Backup withholding also can be triggered when the IRS notifies the bank that your tax identification number is wrong or that you underreported interest or dividends on your income tax return.

Deducting investment expenses

You may be able to deduct some of the money you spent to set up your investments. These include expenses for investment counseling and advice, legal and accounting fees, and investment newsletters. The only limit here is that your investment expenses are to be reported on your itemized deductions form (1040 Schedule A) as miscellaneous deductions. And miscellaneous deductions cannot be subtracted until they exceed 2 percent of your adjusted gross income.