CD Interest, Bank 1099-INT Forms and Taxes
A reader asked me about when a bank is required to send a 1099-INT. Does the bank only need to send a 1099-INT for the tax year when the CD matures? The IRS Publication 550 has many of these details, but first it's easier to understand these issues if CDs are broken into certain categories.
There are two CD maturities to consider: 1) CDs with terms of one year and under, and 2) CDs with terms over one year.
Also, it's important to consider how interest is credited or paid. The two general methods include: 1) interest is credited to the CD monthly, quarterly or annually, and 2) interest is credited only at maturity.
When interest is paid, the CD holder may have arranged for the interest to be mailed to them as a check. The other option is for the interest to be added to the principal of the CD. The CD account holder is typically allowed to withdraw this interest without a penalty.
A bank will sometimes only credit the interest at maturity, but this is typically only done on short-term CDs with maturities of one year or shorter.
The answers on how the CD account holder and the bank should report the interest to the IRS is in the IRS Publication 550. This excerpt from page 6 provides some of these details:
Certificates of deposit and other deferred interest accounts. If you open any of these accounts, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.
So when interest is credited to the CD, this interest must be included in the person's income. Even if you don't receive a check, interest that is added back to the CD can be considered "entitled to receive without paying a substantial penalty." The bank should send out a 1099-INT form for the tax year when interest was credited. As stated in the above excerpt, "interest may be paid at fixed intervals of 1 year or less."
If the CD has a term of one year or less, there may be one single payment of interest at maturity. In that case, the bank may only send out a 1099-INT for the tax year when the CD matured.
The complication is when the CD has a term of over one year. The last sentence of the above excerpt references the section on Original Issue Discount (OID). In that section on page 13, OID is defined:
OID is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.
On page 14, more details are provided for CDs:
If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the same manner as other OID.
So if the bank doesn't pay interest until the CD matures and the CD term is over one year, the bank should send out the form 1099-OID and the CD account holder must include this "phantom interest" or "imputed interest" in his or her income each year.
One well-known exception to reporting OID is the U.S. savings bond. This is the second example of exceptions listed on page 14. You don't have to worry about reporting savings bond interest until you redeem the savings bond or until it reaches maturity after 30 years. That's one nice advantage that savings bonds have over CDs.
If you have a question about your taxes, and what should be reported on them, it is a good idea to consult a tax professional who can help you navigate the rules.