Do You Pay Taxes on a CD Before It Matures?

Certificates of deposit (CDs) are a popular way to earn interest on savings, but many people are unsure how taxes apply to them. Since CDs have fixed terms, it’s easy to assume taxes only matter when the account matures. However, tax rules can be more complex.

Annual Interest Reporting

Banks and credit unions report CD interest to the IRS each year, even if the funds remain locked in the account. Interest income is taxable in the year it is credited, regardless of whether it is withdrawn. For CDs with terms longer than one year, this means taxes may be owed before the CD matures.

For example, if you open a five-year CD in January 2024 with a 4% annual interest rate and deposit $10,000, the bank will credit $400 in interest at the end of the year. Even though you can’t access the funds without breaking the CD, the IRS requires you to report the $400 as taxable income for 2024. This process repeats each year until the CD matures.

Zero-coupon CDs, which do not pay periodic interest but accrue it until maturity, follow different tax rules. Under original issue discount (OID) rules, the IRS requires you to report accrued interest annually, even though you won’t receive the full payout until maturity.

Penalties and Tax on Early Withdrawals

Withdrawing funds from a CD before maturity can result in financial penalties. Most banks impose an early withdrawal penalty, which varies by term length and institution. Penalties typically range from a few months’ worth of interest to a year or more for longer-term accounts. If the interest earned isn’t enough to cover the penalty, some banks may deduct from the principal.

Early withdrawals also affect tax liability. Any withdrawn interest is subject to federal and, in many cases, state income taxes. If interest was previously taxed as it accrued, ensure it isn’t reported again to avoid double taxation.

The IRS allows early withdrawal penalties to be deducted as an adjustment to income, meaning you can claim the deduction even if you don’t itemize. While this offsets some of the tax burden, it does not fully eliminate the financial impact of withdrawing early.

Issued Tax Forms

Financial institutions report CD interest earnings to both the account holder and the IRS using specific tax forms. The most common is Form 1099-INT, which banks issue if total interest earned in a calendar year exceeds $10. This form details the exact amount of interest credited, regardless of whether the funds were withdrawn.

For CDs subject to original issue discount (OID) rules, such as zero-coupon CDs, banks issue Form 1099-OID instead. This form reports the yearly portion of imputed interest that must be included in taxable income, even though the interest won’t be received until maturity. If you receive both Form 1099-INT and Form 1099-OID for the same CD, ensure you are not double-reporting income, as some financial institutions issue both forms for certain accounts.

Withholding or Estimated Payments

Unlike wages, which typically have automatic tax withholding, CD interest does not have withholding by default. However, account holders can request voluntary withholding by submitting Form W-4V (Voluntary Withholding Request) to their financial institution, selecting a federal withholding rate of 7%, 10%, 12%, or 22%. This option helps those who prefer to manage tax liabilities gradually rather than making lump-sum payments at filing time.

If taxes are not withheld, estimated tax payments may be necessary. The IRS requires quarterly estimated payments if you expect to owe at least $1,000 in taxes after subtracting withholdings and refundable credits. This is particularly relevant for retirees and self-employed individuals who do not have regular paycheck withholdings. Estimated payments are due on April 15, June 15, September 15, and January 15 of the following year. Failing to make these payments on time can result in penalties under IRC Section 6654.