How Are CDs Taxed? A Look at Interest and Reporting

A Certificate of Deposit (CD) is a savings account that holds a fixed amount of money for a fixed period, earning interest at a fixed rate. While often seen as a secure investment, the interest earned on CDs is generally considered taxable income.

Core Principles of CD Taxation

Interest income from Certificates of Deposit is classified as ordinary income for federal tax purposes, taxed at your regular income tax rate, similar to wages. This applies whether interest is paid out periodically or reinvested into the CD’s principal.

CD interest may also be subject to state income taxes. Most states with an income tax will tax CD interest based on your individual tax bracket.

Timing of Interest Income Recognition

The Internal Revenue Service (IRS) generally operates on the principle of “constructive receipt,” meaning income is taxed when it is made available to the taxpayer without substantial limitations, even if it is not physically received. This principle dictates the timing of taxability for CD interest.

For CDs with terms of one year or less, interest is typically taxed in the year it is paid or made available. If a short-term CD matures in a different tax year than its purchase, the interest is taxed in the year of maturity. For CDs with terms longer than one year, interest is often taxed annually as it accrues, even if the interest is not paid out until the CD matures. For example, if a five-year CD earns $100 in interest each year, that $100 is taxable in the respective year, not just when the CD fully matures.

Reporting Your CD Interest

Financial institutions are obligated to report interest income to the IRS and to the taxpayer. If you earn $10 or more in CD interest during a calendar year, your bank or credit union will issue Form 1099-INT, Interest Income, by January 31st. This form details the total interest earned.

The interest amount reported in Box 1 of Form 1099-INT is generally reported on your Form 1040. If your total taxable interest income from all sources exceeds $1,500, you will also need to file Schedule B, Interest and Ordinary Dividends.

Key Tax Considerations for Certain Situations

If you incur a penalty for an early withdrawal from a CD, this penalty can reduce your taxable interest income. The amount of the early withdrawal penalty is deductible on your tax return, even if the penalty exceeds the interest earned. This deduction is typically reported on your Form 1040.

CDs held within tax-advantaged retirement accounts, such as a Traditional Individual Retirement Account (IRA), Roth IRA, or 401(k), receive different tax treatment. Interest earned in a Traditional IRA CD is generally tax-deferred, meaning taxes are not paid until funds are withdrawn in retirement. For Roth IRA CDs, contributions are made with after-tax dollars, and qualified withdrawals, including interest, are tax-free in retirement.

Some CDs are issued at a discount, meaning you pay less than the face value and receive the full face value at maturity. This difference is considered Original Issue Discount (OID). For OID CDs, the discount must be accrued and reported as income annually, even if no cash interest is received until maturity. This is typically reported on Form 1099-OID.