Are Certificates of Deposit (CDs) Tax-Exempt?

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Certificates of deposit (CDs) provide a way for consumers to make a little more interest on their savings than they can get by keeping their money in a standard savings account. The customer is promising not to withdraw the money for a specific period of time. The longer the time period, the higher the interest earned.

According to the IRS, you must report your interest income on your tax return and pay taxes on it. This reduces your return on the investment, so it’s important to consider how CD interest is taxed to decide if placing your money in a CD is worth it.

Key Takeaways

• For CD terms longer than one year, you will have to pay taxes on interest earned each tax year during the CD term.
• For CD terms of one year or less, you will have to pay taxes on interest earned and received.
• Early withdrawal penalties offset taxes owed on CD interest.
• CDs may be placed in a tax-deferred retirement account. In this case, taxes on earnings may be deferred until retirement or distributions.

How Does the IRS Tax Interest Earned on a CD?

Any interest that is earned on a CD during the tax year is considered income, and the IRS will tax it as such on your tax return.

If you earn more than $10 in interest, the banking institution holding your CD is required to send you a 1099-INT stating the amount of interest earned on the CD during the tax year. You will receive this document and pay taxes accordingly, even if you roll the principal of the CD into a new CD during the year. However, you do not have to pay taxes if the CD is held in a tax-advantaged retirement account.

In the event you don’t receive a 1099-INT from your banking institution, you still have to report it to the IRS on your tax return.

CDs With Terms of More Than One Year

If your CD has a term of more than one year, you will pay taxes on any interest earned in each year of the CD term. For example, if you have a three-year CD and you earn $15 in interest during the first year of the term, you will report $15 on your tax return as income. During the second year, if you earn another $15 in interest, you will again report $15 on your tax return as income and the same for the remaining year of the CD term.

Exceptions to Paying Taxes on CD Interest

If the CD is placed in a tax-deferred 401(k) or individual retirement account (IRA), any interest earned on the CD may be exempt from paying taxes in the year it was earned. Instead, you will pay taxes on that money when it is withdrawn from the 401(k) or IRA after you retire.

Of course, this is provided that your annual contribution to the retirement account remains below the contribution limits set by the IRS. For 2024, the annual contribution limit for 401(k)s is $23,000, with a maximum catch-up amount for those 50 and older of $7,500. For IRAs, the yearly contribution limit is $7,000; if you're age 50 or older, it's $8,000.

How Much Will I Pay in Taxes in CD Interest?

The amount of taxes you pay on earned CD interest varies based on your tax bracket as well as the dollar amount of your gain. To get an idea of how much you could pay in taxes, talk with a tax professional to evaluate your individual financial situation and provide a tax estimate.

When I Cash a CD, Is It Considered Income?

If your CD has a principal amount of $10,000 and earns $200 in interest at the time you cash it in, only the $200 in earned interest is considered income. You should receive a 1099-INT in the amount of $200 (Box 1) from your banking institution, in that case.

Do Early Withdrawal Penalties Affect How Much I Pay in Taxes for CD Interest?

If you withdraw the money from your CD before its maturity date, your bank likely will charge an early withdrawal penalty. If it does, you can deduct the amount of the early withdrawal from your penalty, which would offset how much you pay in taxes on any earned interest. For instance, if you earned $50 in interest (Box 1 on your 1099-INT), you will pay taxes on that $50. However, if you pay an early withdrawal penalty (Box 2 of your 1099-INT) of, say, $20, you can deduct that amount, leaving you to pay tax on $30 of income.

The Bottom Line

Simply put, yes, the IRS will tax all interest earned on your CD as ordinary income unless the CD is held in a tax-advantaged retirement account. This will be due for each tax year in which the interest is earned. So if you have a three-year CD, you will pay taxes only on the interest earned during the current tax year. If the CD is placed in a 401(k) or IRA account, taxes will be deferred until distributions are taken from those accounts.

1. Internal Revenue Service. "Topic No. 403 Interest Received."
2. CapitalOne. “Understanding CDs and IRA CDs.”
3. Internal Revenue Service. "401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000."
4. Intuit Turbotax. "I Have a Penalty for Early Withdrawal of a CD - on Page 18, Investment Income, It States That I Can Deduct the Amt on Schedule 1, Line 18 - Where Do I Enter This in TT?"
5. Internal Revenue Service. "Instructions for Forms 1099-INT and 1099-OID: Box 2. Early Withdrawal Penalty."

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A CD ladder is an investing strategy which you buy multiple certificates of deposit (CDs) with different maturity dates. Learn how to build a CD ladder.

A certificate of deposit (CD) is a type of savings account offered by banks and credit unions. It pays a fixed interest rate for a set period of time.

A jumbo certificate of deposit (CD) is a type of savings account with higher balance requirements than a traditional CD. It generally pays a higher interest rate.

A deposit interest rate is the interest rate paid to deposit account holders for accounts like certificates of deposit (CD) and savings accounts.

A Christmas club is a savings account to help people save for the holidays. Money is deposited throughout the year and withdrawn before the holidays.

A Negotiable Order of Withdrawal (NOW) Account is an interest-earning bank account. A customer with this type of account can write drafts against money held on deposit.

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