Yes, You Pay Taxes on CD Interest as Ordinary Income

Yes, you pay taxes on CD interest as ordinary income in the year it becomes available to you, regardless of whether you withdraw the funds. For the next step, read our overview of $20 an Hour 40 Hours a Week After Taxes: Net Pay Estimates.

How CD Interest Is Taxed

The IRS treats interest earned on certificates of deposit the same as wages or other ordinary income. It is taxed at your regular federal income tax rate, which ranges from 10 percent to 37 percent depending on your bracket, plus any applicable state taxes. Banks and credit unions report interest of $10 or more on Form 1099-INT, and you must include that amount even if you never receive the form. You can also explore Yes, Property Taxes Continue as Long as You Own for a closer comparison.

Interest is considered earned when it is credited to your account or made available without penalty. For CDs longer than one year, you report the interest each calendar year rather than waiting until maturity. A five-year CD, for example, generates a separate 1099-INT each year showing only the interest accrued during that tax year.

When You Must Report the Income

Reporting occurs in the year the interest is earned, not when the CD matures. Short-term CDs that mature within the same calendar year are reported once on that year’s return. CDs that span two calendar years require reporting in both years based on the actual interest credited each period.

Even if you reinvest the interest or leave it in the CD to compound, the amount is still taxable in the year it accrues. The principal you originally deposited is not taxed again because it was already taxed when earned.

Tax Forms and Required Reporting

Form 1099-INT shows taxable interest in Box 1. You report this figure on Schedule B and line 2b of Form 1040. Tax-exempt interest, if any, appears on line 2a. Early-withdrawal penalties appear in Box 2 and can be deducted above the line, reducing your adjusted gross income even if you do not itemize.

If you receive a 1099-INT that includes interest belonging to someone else, you are considered a nominee and must follow specific reporting steps outlined by the IRS to redirect the income to the actual owner.

Strategies to Defer or Reduce Taxes

Placing a CD inside a traditional IRA or 401(k) defers taxes until you withdraw the money in retirement. A Roth IRA CD allows tax-free growth and tax-free qualified withdrawals. Health savings accounts and 529 plans also permit tax-advantaged CD holdings when the funds are used for qualifying medical or education expenses. For the next step, read our overview of How Tax Attorneys Help Resolve Back Taxes.

Joint CDs may shift some interest to a spouse in a lower tax bracket, lowering the household tax bill in certain cases. State rules vary, so the federal deferral benefit does not always extend to state returns.

Early Withdrawal and Inherited CDs

Early withdrawal penalties reduce taxable income and are reported on the 1099-INT. The deduction applies even when the penalty exceeds the interest earned that year.

When a beneficiary inherits a CD, the original principal and interest earned through the date of death are generally not taxable as income. Interest earned after the date of death becomes taxable to the new owner. Federal estate tax applies only to very large estates, while state inheritance or estate taxes depend on the beneficiary’s location.

Consequences of Not Reporting CD Interest

Failing to report interest can trigger an IRS underreported-income notice. You will owe the tax plus interest and possible penalties. The IRS receives copies of all 1099-INT forms, so unreported amounts are easily matched to your return.

Sources

• Topic no. 403, Interest received
• How are CDs Taxed? Learn More About the Process
• How to avoid taxes on CD interest