Do You Have to Pay Taxes on CD Interest?
Understand the tax rules for Certificates of Deposit. Interest is typically taxed as ordinary income annually, even before your CD matures.
Interest earned on a Certificate of Deposit (CD) is considered taxable income by the Internal Revenue Service (IRS). Financial institutions are required to report this income to both you and the IRS, meaning it must be accounted for when you file your annual tax return. The tax liability exists regardless of whether you have withdrawn the interest or allowed it to be reinvested into the CD.
How CD Interest is Taxed
The interest you earn from a CD is taxed as ordinary income, which is the same category as wages and salaries. This means the interest is subject to your regular federal income tax rate, which depends on your total taxable income and filing status. For example, if you are in the 22% federal tax bracket, the interest earned on your CD will also be taxed at 22%. This differs from other types of investment income, such as long-term capital gains, which often benefit from lower tax rates.
The timing of CD taxation is important. You are required to pay taxes on the interest in the year it is credited to your account, not when the CD matures or when you withdraw the funds. For CDs with terms longer than one year, this can lead to a situation where you owe tax on “phantom income”—money that has been earned but is not yet accessible without penalty. This is governed by the Original Issue Discount (OID) rules.
The IRS uses OID rules for long-term CDs to ensure that interest is taxed annually as it accrues. OID is a form of interest that represents the difference between a debt instrument’s stated redemption price at maturity and its issue price. For a CD with a term exceeding one year, the bank calculates the interest earned each year, and you are responsible for paying tax on that amount annually, even if it is not paid out until maturity. State and local income taxes may also apply to the interest earned.
Reporting CD Interest Income
If you earn $10 or more in interest during the calendar year, your financial institution must send you Form 1099-INT, Interest Income. This form details the total taxable interest you have earned for the year, which is shown in Box 1.
For certain long-term CDs, you might receive Form 1099-OID, Original Issue Discount, instead. Box 1 of Form 1099-OID reports the amount of OID you must include in your income for the year, while Box 2 shows any other periodic interest you were paid.
You must report the interest income shown on these forms on your personal tax return, Form 1040. If your total interest income from all sources exceeds $1,500, you are also required to file Schedule B, Interest and Ordinary Dividends. This schedule requires you to list each payer of interest and the amount received.
Special Circumstances for CDs
Standard tax rules for CDs do not apply when held within a tax-advantaged retirement account, like a Traditional or Roth IRA. In a Traditional IRA, interest grows on a tax-deferred basis, and taxes are paid on withdrawals during retirement. For CDs in a Roth IRA, the interest growth is tax-free, and qualified withdrawals in retirement are not taxed.
If you withdraw funds from a CD before its maturity date, you will face an early withdrawal penalty. This penalty is tax-deductible as an adjustment to your income. The financial institution reports the penalty, and this deduction is available even if you do not itemize. This deduction can offset the taxable interest income you earned.
When a CD is owned by a minor, the interest income may be subject to the “kiddie tax.” This rule applies to unearned income, like CD interest, above a certain threshold for a child. If the child’s interest income is significant, it may be taxed at their parents’ higher marginal tax rate rather than the child’s lower rate. This prevents parents from shifting investment income to their children to take advantage of a lower tax bracket.