Do You Pay Taxes on CD Interest? Here’s What to Know
Understand the tax implications of CD interest, including reporting requirements and differences in state and federal filings.
Certificates of Deposit (CDs) are a popular savings option for individuals looking to earn interest on their deposits with minimal risk. However, understanding the tax implications associated with CD interest is crucial for ensuring compliance with tax regulations and optimizing your financial strategy.
Taxable Treatment of CD Interest
Interest earned from Certificates of Deposit (CDs) is considered ordinary income by the Internal Revenue Service (IRS) and is subject to federal income tax in the year it is earned, whether withdrawn or compounded. The tax rate applied to CD interest corresponds to your marginal tax rate, which ranges from 10% to 37% for the 2024 tax year, depending on total taxable income.
Financial institutions report interest income exceeding $10 on Form 1099-INT, which is sent to both the taxpayer and the IRS. This form is essential for accurately reporting interest income on your tax return. Even if a 1099-INT is not received, taxpayers are still responsible for reporting all interest income, including interest credited annually on CDs with multi-year terms but not paid out until maturity.
CDs held in tax-advantaged accounts like IRAs or 401(k)s have different tax rules. Interest earned in these accounts is tax-deferred and only taxed upon withdrawal, typically during retirement. This allows interest to compound tax-free. However, early withdrawals may result in penalties and taxes, so understanding the rules for your specific retirement account is important.
Forms and Reporting Requirements
Form 1099-INT is the primary document for reporting CD interest, issued by financial institutions when interest income exceeds $10. This form provides details on interest earned and is necessary for preparing an accurate tax return. Taxpayers should always verify the information on the form against their own records.
Interest income must be reported on individual tax returns. If total interest exceeds $1,500, it must be itemized on Schedule B of Form 1040. Taxpayers with foreign accounts or other complex arrangements may also need to file additional forms, such as the FBAR (FinCEN Form 114) or Form 8938.
State and Federal Filing Differences
State and federal tax requirements for CD interest can vary. Federally, all interest income must be reported as taxable income, using forms like the 1099-INT and Schedule B. State tax rules, however, differ based on the state’s tax code.
States like Florida and Texas, which do not impose state income taxes, exempt residents from additional taxation on CD interest. In contrast, states like California and New York require residents to include CD interest on their state tax returns, potentially increasing the effective tax rate. Some states offer deductions or credits to offset the tax burden, so it’s important to review your specific state’s tax rules.
Consequences for Non-Reporting
Failing to report CD interest can lead to significant penalties and complications. The IRS uses forms such as the 1099-INT to verify the accuracy of tax returns. Discrepancies between reported income and IRS records may trigger an audit. If underreported income is identified, penalties, interest on unpaid taxes, or even legal action may follow.
Penalties for non-reporting depend on the extent of the omission. The IRS may impose fines ranging from $50 to $280 per form for failing to file a correct information return, depending on how late the form is filed. Additionally, interest accrues on unpaid taxes from the return’s due date until the liability is resolved, increasing the financial burden.