Is Money Market Income Dividend or Interest Income?

Money markets instruments consist of short-term Treasury bills, short-term commercial debt, certificates of deposit and other interest-bearing securities and contracts with very short lifetimes. Earnings from a money market may be free of federal tax to the extent that the money market invests in tax-free municipal short-term notes. Depending on where you live, the earnings may be free from state and local taxes as well.

Money market bank accounts are usually insured by the Federal Deposit Insurance Corp. up to a limit of $250,000. These accounts pay interest that you can allow to compound. Bank money market accounts have certain restrictions on the number of withdrawals and checks written in a month. Not surprisingly, there is no limit on the number of deposits you can make. Bank money market interest is subject to taxation at your marginal tax rate.

Although not insured by the FDIC, most money market funds are insured by the Security Investor Protection Corp. up to $500,000. Money market funds pay their earnings as dividends, but these dividends do not qualify for a tax break — they are taxed at your marginal interest rate unless the fund is set up to be tax-free. Mutual fund companies always strive to keep the share price of a money market fund at exactly $1. In the past, fund companies have reimbursed customers when the share net asset value fell below the dollar level.

There are no capital gains on money market funds because the value of the shares stays fixed at $1. A capital loss is possible if the shares fall below $1 and are not reimbursed by the fund company. Bank money market accounts are also free of capital gains and are insured against losses.

Whether reported as interest or dividends, the income from a money market is treated as investment income for purposes of computing Medicare tax. This tax was introduced in 2013 and applies to single taxpayers with modified adjusted gross income exceeding $200,000 or couples with a MAGI exceeding $250,000. The amount of the tax is 3.8 percent on the lesser of your investment income or your MAGI exceeding the noted limits. Oh yes, that tax-free income you earned from a municipal money market fund is also subject to the Medicare tax.