Is Money Market Income Dividend or Interest Income?

Money market funds are relatively safe but don't pay much.
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All money market income is subject to the same tax rate, no matter how it’s labeled. The income you receive from a money market is classified according to whether it’s from a bank money market account or a money market mutual fund. Bank money market account income is reported as interest on Internal Revenue Service Form 1099-INT, whereas mutual fund money markets send you IRS Form 1099-DIV, which lists your dividend income.

Money Market Instruments

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.

Bank Money Market Accounts

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.

Money Market Mutual Funds

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.

Capital Gains

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.

Medicare Tax

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.

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