Credit Union vs. Bank: Which Should You Choose?
What Is a Joint Bank Account, and Is It Right for You?
How to Write a Check: Your Step-by-Step GuideCD Interest, Bank 1099-INT Forms and Taxes
I first published this article several years ago. I thought this would be a good time to refresh this article as savers prepare their tax returns. Unless you hold a CD in an IRA or other retirement account, you have to pay taxes each year on the interest earned from a CD.
Interest from a CD is taxable whether the CD is from a bank or credit union. At credit unions, a CD is often called a share certificate and interest is often called dividends, but from the IRS perspective, there is no difference between interest from a bank CD or dividends from a credit union share certificate.
The bank or credit union should send you the Form 1099-INT by January 31st which lists the interest earned during the previous year. Institutions don’t have to send them if interest earned is under $10. Also, you may not receive a paper Form 1099-INT in the mail if you accepted your bank’s account agreement for receiving bank documents (including Form 1099-INT) electronically.
My original article focused on the question about what years during the term of a CD should you expect to receive Form 1099-INT from your bank. This updated article will also help you understand how much interest earned for a particular year will be listed in Form 1099-INT and how early withdrawal penalties are included. My source for the answers is the IRS Publication 550.
Interest is Taxable Whether It’s Paid Out or Reinvested
The first important thing to understand is that from a tax point-of-view, it doesn’t matter if interest is added back to the principal of the CD or paid out to you by check or ACH. In either case, it’s considered taxable interest. For those new to CDs, this might be an unpleasant surprise if you had thought you wouldn’t be paying taxes on a CD when you didn’t receive an interest payment.
When Taxes Are Owed on CD Interest
Taxes will be owed for the years when interest is paid by the CD. The IRS Publication 550 describes the limits of when banks can pay interest on CDs:
Certificates of deposit and other deferred interest accounts. If you buy a certificate of deposit or open a deferred interest account, 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.
First, note that interest is to be paid “at fixed intervals of 1 year or less.” Thus, there will be yearly interest to report for CDs with multiple-year terms. There will not be just one payment of interest at maturity. The first payment of interest may be delayed up to one year from account opening. For example, if you opened a 3-year CD today and the CD only pays interest on yearly intervals from the day the account was opened, you will not have interest paid this year, and thus, you will not receive Form 1099-INT for this CD next January. However, if the CD pays interest monthly and you open the CD before December, you should expect to receive Form 1099-INT for this CD next January.
Second, note that for CDs with terms of one year or less, interest can be paid in a single payment at maturity. Thus, if you open a 1-year CD today and the CD only pays interest at maturity, you won’t have any taxable interest on that CD for this year, and you shouldn’t expect to receive Form 1099-INT for this CD next January.
Some banks allow you to specify the intervals of when interest will be paid. For example, if you open a CD at Ally Bank with a term of one year or less, the default will be for interest to be credited to your CD at maturity. Customers also have the option to change payment to be done monthly, quarterly or annually. If you choose these other intervals for a 1-year CD, you may have taxable interest for two tax years.
Original Issue Discount (OID) and CDs
There’s a complication when a CD has a term of over one year and the bank chooses to pay interest only at maturity. The last sentence of the above excerpt references the section on Original Issue Discount (OID). The OID section of Publication 550 defines OID as follows:
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.
More details on OID specific to CDs are provided in the next page of the OID section:
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 in the OID section. 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.
How Early Withdrawal Penalty Affects Taxes Owed
In addition to interest income, Form 1099-INT can include an early withdrawal penalty. There are separate boxes on Form 1099-INT for both interest and an early withdrawal penalty. In most cases, when you withdraw principal from a CD before it matures, the bank will charge you an early withdrawal penalty. The Publication 550 provides the following instructions on reporting early withdrawal penalties:
The Form 1099-INT or similar statement given to you by the financial institution will show the total amount of interest in box 1 and will show the penalty separately in box 2. You must include in income all interest shown in box 1. You can deduct the penalty on Form 1040, line 30. Deduct the entire penalty even if it is more than your interest income.
It might seem strange that an early withdrawal penalty (EWP) can be more than the interest. This can occur if the early withdrawal is done early in the term of a CD. For example, if the EWP is equal to six months of interest and you close the CD three months from the date it was opened, the EWP will be twice the amount of the interest. Another way an EWP can be larger than the interest on the 1099-INT is if interest from the CD was reported in previous tax years. Not much interest may have been paid in the tax year when the EWP occurred.
Taxes on Savings and Money Market Account Interest
As you can see from above, interest reporting on a CD has a few complications. Interest reporting on a savings, checking or money market account is more straightforward. For these types of liquid bank accounts, there are typically no early withdrawal penalties. Second, interest is typically paid monthly. So you should expect to have interest income for the years you own a liquid bank account. The only exception would be if you opened the account in December. If the bank pays interest on monthly intervals starting a month from the opening date, no interest might be paid in that year.
This article contains general information and should not be considered tax advice. 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.
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1099-INT
Line 1 Interest Income
Line 2 Early Withdrawal Penalty
Make sure you're looking at the correct line.
It's also possible to earn interest and incur the EWP, depending on when you cashed it in.
The EWP goes on line 30 of your 1040 tax form.
Thank you...at least it's still line 30!
For deposit terms under 1 year, however, the situation isn't as clear.
You indicate interest is ACCUMULATING and is FULLY CREDITED monthly
(not just AT MATURITY?). If so, you're potentially liable for 2018 tax.
But, since you also indicate your institution doesn't permit penalty free
interest withdrawals until maturity, IRS Publication 550, pg. 5, Section
"Certificates of deposit and other deferred interest accounts"
may apply, providing a loophole.
"If you buy a certificate of deposit or open a deferred interest account,
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."
However, if you DO receive a 2018 1099-INT non-zero interest report for this account,
I'd seek further expert advice before attempting 2019 deferral!
Other DA tax analyst opinions/interpretations welcome!
https://finance.zacks.com/tax-payable-matured-certificate-deposit-9085.html
This article claims that short-term CD ( 1 yr, interest needs to be reported annually. Anyone have any experience with tax reporting of short term CDs?
Ken mentioned that interest earned on U.S. Savings Bonds are exempt from the OID rules that require interest to be picked up annually over the life of the bonds, so that interest need not be taxed until the year th bonds are redeemed. However, one can elect instead to pick up the interest annually, as if OID. That may be a good option if the bonds are in the names of very young children, as they are likely to have very little (if any) tax liabilty until their first working years.
QUESTION..... IS THAT ALSO CONSIDERED A PENALTY AND CAN YOU DEDUCT THAT AMOUNT ON YOUR TAXES.................HAVE NOT SEEN ANY COMMENTS OR FACTUAL INFO ON THAT SUBJECT WHEN IT APPLIES TO ROTH IRA....PLEASE COMMENT!!!!!!!!!!
Does anybody here who has brokered CD's know the answer?
"You must treat any gain when you dispose of the bond as ordinary interest income, up to the amount of the accrued market discount."
CDs are treated the same as bonds for this purpose.
https://www.investopedia.com/terms/d/deminimistaxrule.asp
As I understand it OID does not apply to secondary market CD's because the originating bank has nothing to do with it. If you pay $98 for a secondary market CD paying 4% and it matures years later at par ($100) you owe a capital gain tax on the $2. Also, you owe annual taxes on the 4% interest earned.
$100,000 CD paying 4% interest
Purchased on secondary market for $98,000
Pay annual tax on $4,000 (4%) interest.
At maturity collect $100,000 and pay a gain tax on $2,000
When buying secondary issues it's vital to note the YTM value.
Or do I have to keep up with this myself? (nightmare :)
My CD sales already show the gain/loss and it will be reported next year on the tax statement. You should see the same thing for secondary issues (buy/sell/gain/loss) sold at maturity.
My online tax return program is easy & speedy. It figures all the EWP stuff. I actually look forward to filing my return every year because it's so simple. But I gotta admit, the interest thrown off from all my CDs causes me to owe money to the IRS each year. I probably only keep about 50% of my interest? But I'll take it. Still better than earning nothing.
That sounds like annual compounding (interest paid every 12 months). It keeps the APR lower than it would be with shorter interest payment terms (monthly, quarterly, etc.).
Sure but the usual point of annual interest is a lower APR. It also eliminates monthly/quarterly interest distributions.
In terms of odd things a person might look out for concerning 1099 forms - I received (hopefully) my final 2018 1099 in today's mail, from Edward Jones. I puzzled over why I got it via snail-mail at all, instead of online. Then I remembered that I'd closed that account last spring, and requested that online access be shut down also. (This was for security reasons - who really wants online access to a closed account to be maintained? I've noticed that financial institutions differ on their policies concerning this - some just leave the online access for closed accounts available; some don't.) Anyway, even though my Edward Jones 1099s have been online for the past several years, per my request, this final one had to be snail-mailed. The same might be true for anyone else who closed a financial / brokerage account last year.
https://en.wikipedia.org/wiki/Constructive_receipt
http://taxplancalculator.com/
for anyone interested in seeing how your 2018 taxes changed after tax reform.
The reason I'm posting is I've started to read and hear complaints from people upset they have to pay this year instead of receiving a refund. If withholding amounts were not adjusted it is quite possible you received more money throughout the year due to the tax relief bill, that not enough tax was deducted and that you will receive a lower refund or owe tax as a result. I am amazed when I read people consider the absence of a refund as a "loss of income" but that's how mathematically ignorant our population has become.
The program I listed is very accurate. It does not account for every situation but I've run several scenarios that all proved accurate. One thing that may negatively affect your federal tax are the changes made to the SALT deductions. SALT, for example, allowed people with large homes to deduct very large amounts of interest along with state/local taxes that are, in many cases, exorbitant. In the past, the modest homeowner with lower property taxes in a state with lower taxation rates paid a higher effective rate of taxation than their wealthier counterpart due to less deductions on their 1040. In effect, the modest tax payer subsidized the wealthier.
We live in a modest home with modest taxes with a high income. Property taxes are $5,000. Our Federal TAX SAVING this year due to the tax bill is $5,184. Here's the "TAX SAVING" calculation if our property taxes were higher.
Property tax $10,000 TAX SAVING = $4,746
Property tax $15,000 TAX SAVING = $3,346
This can become confusing very quickly so let's simplify it for someone making $100K by only deducting the property taxes (as we did in the past).
Property tax deduction $5,000 = Taxable Income $95,000 (pays the most in fed taxes)
Property tax deduction $10,000 = Taxable Income $90,000 (second most fed taxes)
Property tax deduction $15,000 = Taxable Income $85,000 (lowest fed tax of the bunch)
I'm old-fashioned. Did we pay more or less? We paid less federal taxes. Since I adjusted withholding a year ago, for the first time in 40 years, we will receive a small refund. The bottom line is our tax bill for 2018 is $5,184 less than it would have been without tax reform.
Some will comment on the standard deductions of the past/present saying many did not itemize, etc. etc. The so-called SALT subsidy, however, was real and is a bone of contention to those who no longer benefit from it.
Thanks.
I was motivated by a newspaper article telling the world how upset a MATH teacher was with the results of their tax preparation. Arguing that the absence of year-end refund, in spite of lower taxation for the year, was a loss of income was mind-numbing.
We have created an entire generation of fools who believe a tax refund is a good thing. These people are so poor at managing basic finances they need a tax refund to finance vacations, etc. A refund simply means you gave the government a 0% interest loan.
Weekly tax receipts are used to fund on-going government business. How is that not obvious? Besides, how many would have the cash on hand at the end of the year to pay the IRS? The number 0 was invented for a reason.
Thanks to all.
mid stream?