Interest from a money market account or fund is generally taxed as ordinary income at your federal marginal rate, which runs from 10% to 37% for 2026. Municipal money market funds are the main exception: their interest is generally exempt from federal income tax. Treasury money market funds sit in between, fully taxed at the federal level but usually free of state and local income tax. What you actually owe depends on the type of fund, where its holdings are issued, your state of residence, and your income.
The Default: Ordinary Income at Your Marginal Rate
The IRS treats interest from a standard money market account or taxable money market fund the way it treats wages or bank savings interest. It stacks on top of your other income and is taxed at whatever bracket it falls into. For 2026, a single filer pays 10% on the first $12,400 of taxable income, then 12%, 22%, 24%, 32%, and 35%, reaching 37% above $640,600. Married couples filing jointly hit the 37% rate above $768,700.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
These earnings are not capital gains. Money market funds are structured to hold their share price at or very near $1.00, so distributions represent interest earned on short-term debt, not appreciation.2Office of Financial Research. Money Market Funds’ Floating NAVs Stay in Narrow Range for Now That matters because it rules out the lower long-term capital gains rates. Every dollar is ordinary income.
You owe tax in the year the interest is credited to your account, whether or not you withdraw it. Under the constructive receipt rule, once the money is available to you without restrictions, it counts as received.3eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income
The 3.8% Net Investment Income Tax
Higher earners owe an extra 3.8% on top of the ordinary rate. The net investment income tax kicks in when your modified adjusted gross income exceeds $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately).4Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax The 3.8% applies to the smaller of your net investment income or the amount your MAGI exceeds the threshold.5Internal Revenue Service. Topic No. 559, Net Investment Income Tax
These thresholds are set by statute and don’t adjust for inflation, so more taxpayers cross them each year. Someone in the 32% bracket with meaningful money market holdings can pay a combined 35.8% on that interest.
Municipal Money Market Funds
Municipal money market funds hold short-term debt issued by state and local governments. The interest is generally excluded from federal gross income.6Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds That exemption is what makes muni funds worth the lower yield for high-bracket investors.
You still report the interest on your return. It doesn’t feed the tax calculation, but it does feed your modified adjusted gross income, which controls eligibility for various credits and deductions.
One boundary is worth knowing. Interest from certain private activity bonds is a preference item under the Alternative Minimum Tax.7Internal Revenue Service. TEB Phase II – Lesson 4 General Rules for Private Activity Bonds If your muni fund holds these bonds, that slice of interest gets added back when you calculate AMT. Check Box 13 of your 1099-DIV (or Box 9 of a 1099-INT) to see whether any of your income falls into this category.
Treasury Money Market Funds and State Taxes
Funds that invest in U.S. Treasury securities and other direct federal obligations pay interest that’s fully taxable federally but typically exempt from state and local income tax. Federal law generally prohibits states from taxing interest on federal debt, and most states honor this by exempting the Treasury-derived share of a fund’s distributions.
Some states attach conditions. California, Connecticut, and New York require the fund to hold at least 50% of its assets in qualifying federal obligations at each fiscal quarter-end before the exemption applies. Your fund company publishes an annual breakdown showing the percentage of income derived from government obligations; multiply that percentage by your total distribution to find what you can exclude on your state return.
State and Local Tax on Money Market Interest
Standard taxable money market interest is subject to state and local income tax on top of your federal bill. Nothing special there.
Muni funds are more complicated. Interest from bonds issued by your own state of residence is usually exempt from both federal and state tax. Interest from out-of-state bonds is federally exempt but generally taxed by your state. Because most muni money market funds hold bonds from many states, your fund company reports the percentage of income by state of issuance, and your state return will typically require you to add back the out-of-state portion. If you want the full double exemption and live in a high-tax state, look for a fund that concentrates on your home state’s issues.
Money Market Funds Inside Retirement Accounts
If your money market fund sits inside a traditional IRA or 401(k), the interest isn’t taxed as it’s earned. It grows tax-deferred, and you pay ordinary income tax on withdrawals. Inside a Roth IRA or Roth 401(k), qualified withdrawals are tax-free.
Holding a municipal money market fund inside a retirement account is almost always the wrong call. You accept a lower yield for a federal tax exemption the account already provides. A taxable or Treasury money market fund generally offers a higher pre-tax yield, and inside the wrapper that yield compounds without current tax drag.
The Medicare Premium Trap
Money market interest can raise your Medicare costs even when it isn’t taxed. Medicare Part B and Part D premiums include an income-related monthly adjustment amount (IRMAA) for higher earners, based on your MAGI from two years prior.
For 2026, a single filer with MAGI above $109,000, or a joint filer above $218,000, pays a higher Part B premium. Surcharges range from $81.20 per month at the first tier to $487.00 per month at the top.8Centers for Medicare & Medicaid Services (CMS). 2026 Medicare Parts A and B Premiums and Deductibles Part D carries similar surcharges at the same income thresholds.
Tax-exempt muni interest counts toward MAGI for IRMAA. A retiree with a large muni money market position can find that “tax-free” income has pushed them into a higher IRMAA bracket, adding thousands to their annual premiums.
Comparing Taxable and Tax-Exempt Yields
A muni fund yielding 3.2% and a taxable fund yielding 4.5% aren’t directly comparable. Convert with the tax-equivalent yield formula: divide the tax-exempt yield by one minus your marginal tax rate.
In the 32% federal bracket, a 3.2% muni yield equates to 3.2% ÷ (1 − 0.32) = 4.71%. That beats the 4.5% taxable fund after tax. Add 3.8% NIIT if it applies, and the gap widens. If your state also exempts the interest, divide by one minus your combined federal and state marginal rate. Someone in the 24% bracket may find the taxable fund wins; someone at 37% plus NIIT almost always comes out ahead in munis.
Reporting the Interest on Your Return
The form depends on what you hold. A bank money market account produces Form 1099-INT: taxable interest in Box 1, tax-exempt interest in Box 8.9Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID (Rev. January 2024) A money market mutual fund produces Form 1099-DIV instead: ordinary dividends from a taxable fund in Box 1a, exempt-interest dividends from a muni fund in Box 12, and private activity bond interest in Box 13.10Internal Revenue Service. Instructions for Form 1099-DIV (01/2024)
If your taxable interest and ordinary dividends together exceed $1,500 for the year, file Schedule B with your Form 1040.11Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends Below that, report directly on the 1040. Tax-exempt interest goes on Form 1040 line 2a: it doesn’t affect the tax calculation, but you’re required to disclose it because it feeds MAGI.12Internal Revenue Service. Instructions for Schedule B (Form 1040) (2025)
Backup Withholding
If you haven’t given your bank or fund company a valid taxpayer identification number, they must withhold 24% of your interest and send it to the IRS.13Internal Revenue Service. Publication 15 (2026), (Circular E), Employer’s Tax Guide You can claim it as a credit when you file, but the cash is out of your hands in the meantime. Keep a current W-9 on file at every institution.
Estimated Tax
Money market interest arrives without automatic withholding. If it will push you to owe at least $1,000 above what’s covered by withholding elsewhere, the IRS expects quarterly estimated payments. You generally avoid an underpayment penalty by paying at least 90% of the current year’s tax or 100% of the prior year’s tax through withholding and estimates combined.14Internal Revenue Service. Pay As You Go, So You Won’t Owe: A Guide to Withholding, Estimated Taxes, and Ways to Avoid the Estimated Tax Penalty