If you earn it, the tax man will come.
That’s just as true for interest income as it is for many other types of income, like what you make at your day job, side hustle, rentals or any other income.
Unless a source of income is specifically covered by its own tax rules, it’s best to assume that it will show up on IRS reporting forms where you earned it — boss or bank — and that the IRS will expect you to include it when it’s time to pay your income taxes.
Are CDs taxable?
Most likely, income from your certificates of deposit (CDs) is going to hit your tax return as “ordinary income tax,” said Christopher Johns, founder of Spark Wealth Advisors, an independent registered investment advisor.
“Both CD and bond interest is subject to ordinary income tax, which depends on the owner’s marginal tax bracket,” he said. “It is important to understand this when choosing a CD or bond, as well as the type of account it will be held in. If held in a traditional IRA, for example, all interest is tax-deferred until withdrawn from the IRA.”
How is CD interest taxed?
CD interest is subject to ordinary income tax, like other money that you earn. The IRS requires investors to pay taxes on CD interest income. The bank or financial institution that holds the CD is required to send you a Form 1099-INT by January 31. This form will document the amount of interest your CD accrued in the prior year. Even if you took out the CD late in the year, you will receive a Form 1099-INT if the interest you earned was over $10. The bank or financial institution also sends a copy of this form to the IRS, which means the tax authorities will know the total amount of earned interest on all your CDs and other interest-bearing accounts.
Because you know when these forms will arrive, you have a chance to look over your income tax returns and organize your paperwork. Find the “taxable interest” section of your tax return and compile all the documentation for the interest income you received that tax year, including from your CDs. Each source of interest income should be supported by documentation from the bank or institution where you held that account.
Two factors might affect how much tax you must pay on the CD interest. If you withdrew funds from a CD early and paid an early withdrawal penalty, typically amounting to three months to a year’s worth of interest, those penalties might offset some or all of the interest income.
Separately, if your CD is held within a tax-advantaged account, such as a retirement savings account, that account might shelter the CD interest from taxes for now. But your tax considerations will change when that tax-advantaged account “goes live” and you start withdrawing money in retirement. It’s a good idea to get in the habit of matching interest income statements with running totals of your interest income so you can manage this source of income in retirement.
Know that even if you don’t end up paying much or any taxes on the interest, you still must remind the IRS that you received interest income by reporting it on your income tax return.
When do you pay tax on CDs?
Taxes on CD income are due in the year that the income was generated. The bank or financial institution where you hold the account will send you a Form 1099-INT that totals the interest income you received in the taxable year so you can slot that into the correct line on your income tax return.
How to report CD interest on tax returns
Once you get your 1099 form from the financial institution through which you have the CD, you must accurately fit that into your tax return, either on the line for interest income or, if your interest income for that year was $1,500 or more, through a Schedule B form (Form 1040).
How to avoid paying taxes on CDs
“The interest you earn is usually taxable, but there are some exceptions, like if it’s in a tax-advantaged account,” says Taylor Kovar, a certified financial planner who runs his own firm, Kovar Wealth Management.
Ask your advisor or tax professional any questions about CD interest and taxes before you get started and it’s also possible to shelter some CD interest income by buying the CDs through tax-advantaged retirement savings accounts, he said.
How does withdrawal from a CD affect your taxes?
If you withdraw your CD before it matures, you will likely pay fees, which might cancel out any interest you have earned to date or even erode the principal you originally put in. You don’t have to pay taxes on interest you didn’t earn. But if you have substantial penalties, you might be eligible to deduct the penalty amount, which could offset the taxes you owe for whatever CD interest was earned before you cashed it out. The financial institution should provide you with a Form 1099-OID that documents both the interest you earned and the amount of the penalties for early withdrawal.
Comparing taxes on CDs to other investments
Because CD-earned interest usually is taxable, cautious investors often consider other low-risk investments, said Kendall Meade, a certified financial planner with SoFi. “Those who are tax sensitive may prefer municipal bonds which are exempt from federal income taxes.“
Treasury bonds are usually less risky than bank or corporate bonds, she added, though low risk does not mean no risk.
How to reduce tax payments on CD interest
The best way to minimize taxes on a CD is to buy it within the framework of a tax-advantaged account, says Meade. Of course, that only delays — not cancels — taxes due on interest income.
If one of your primary goals is to minimize taxes on CD interest income through tax-advantaged accounts, it’s best to consult a certified financial advisor or tax professional who can help you develop a plan for minimizing the taxes you eventually pay.
That plan might involve taking interest income from certain accounts at certain times in a certain order. Tax strategies quickly become complicated, which is why it’s often smartest to confer with a tax accountant or financial advisor whose practice includes tax-minimization strategies.
Frequently asked questions (FAQs)
The primary account holder is issued one 1099-INT to document the interest income on the CD.
Tax fraud is a serious matter that can invoke penalties and even charges. The financial institution that held the CD for you is obligated to document all interest payments, so there is little room to hide.
A CD that matures within a calendar year will yield interest income within that year. Longer-term CDs might yield taxable interest income over two or more years. You, the account holder, must pay taxes for each year that interest income accrues.
States apply their own tax levies on interest income. It’s important to check in advance if you will owe taxes in your state. As with your federal income tax return, review the form in advance to see where you are expected to list potentially taxable interest income. As year-end statements arrive from your bank or financial institution, you will know where that information belongs on the tax return.
No, the return of your principal does not count as income. If you cash in a CD, taxes are only paid on the interest earned, not on the principal.
